HELIOS TECHNOLOGIES, INC. (HLIO)

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

The operating results of the Hydraulics and Electronics segments included in Management’s Discussion and Analysis of Financial Condition and Results of Operations are presented on a basis consistent with our internal management reporting. Segment information included in Note 16 of the Notes to the Consolidated Financial Statements included in this Annual Report is also presented on this basis. All differences between our internal management reporting basis and accounting principles generally accepted in the U.S. (“U.S. GAAP”), specifically the allocation of certain corporate and acquisition-related costs, are included in Corporate and Other.

Overview

We are a global leader in highly engineered motion control and electronic controls technology for diverse end markets, including construction, material handling, agriculture, industrial, mobile, energy, recreational vehicles, marine and health and wellness.

We operate under two business segments: Hydraulics and Electronics. The Hydraulics segment designs and manufactures hydraulic motion control and fluid conveyance technology products, including cartridge valves, manifolds, quick release couplings as well as engineers hydraulic solutions and in some cases complete systems. The Electronics segment designs and manufactures customized electronic controls systems, displays, wire harnesses, and software solutions for a variety of end markets.

With our global operating network we have the advantages of leveraging sales, marketing, innovation, customer relationships and operational excellence across all our businesses. We are committed to furthering the mission of integrating the businesses and leveraging resources to best serve our customers and explore new opportunities.

Acquisitions

Our acquisition activity over the past three years, driven by our strategic vision, has enabled us to diversify our product offerings and the markets we serve and expand our geographic presence.

In July 2022, we completed the acquisition of the assets of Taimi R&D, Inc., a Canadian manufacturer of innovative hydraulic components that offers ball-less design swivel products, which improve hydraulic reliability of equipment, increase the service life of components and help protect the environment by reduced leakage. Taimi brings a differentiated, yet complementary product line to our hydraulics platform as well as strong engineering breadth.

In September 2022, we completed the acquisition of Daman Products Company, headquartered in Mishawaka, Indiana. Daman is a leading designer and manufacturer of standard and custom precision hydraulic manifolds and other fluid conveyance products for its customer base, predominantly in North America. The acquisition of Daman expands the Company's technologies and markets and provides an opportunity to produce integrated package offerings with multiple Helios brands.

In January 2023, we completed the acquisition of Schultes Precision Manufacturing, Inc. Schultes is a highly trusted specialist in manufacturing precision machined components and assemblies for customers requiring very tight tolerances, superior quality, and exceptional value-added manufacturing processes. Currently serving the hydraulic, aerospace, communication, food services, medical device, and dental industries, Schultes brings the manufacturing quality, reliability, and responsiveness critical to its customers’ success. Schultes provides additional manufacturing know-how and expands our business into new end markets with attractive secular tailwinds.

In May 2023, we completed the acquisition of i3 Product Development. i3 is a custom engineering services firm, with engineers specializing in electronics, mechanical, industrial, embedded and software engineering. i3 specializes in working to transform customer’s ideas into industrial design solutions through rapid prototyping and creating 3D models in-house. Their solutions are used across many sectors, including medical, off-highway, recreational and commercial marine, power sports, health and wellness, agriculture, consumer goods, industrial, sports and fitness.

In 2024, the Company continued to explore and evaluate potential acquisitions, but no acquisitions were executed.

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Global Economic Conditions

Geo-Political Conflict

We continue to monitor the ongoing conflicts in Ukraine and in the Middle East and evaluate the broader economic impact those conflicts could have on our operations, supply channels and the operations of our partners and customers. We do not have operations in these regions at this time and those conflicts have not and are not expected to have a material impact on our financial condition or results. Refer to Item 1A Risk Factors of this Annual Report for additional discussion about geo-political risks.

Supply Chain

While there were no impacts to operations resulting from the COVID-19 Pandemic in 2024, for comparison purposes the results in the early part of 2023 faced constraints related to sourcing certain electronic and other components, which originated from the high demand for these products caused by the pandemic. We were able to mitigate some of the impact with our procurement efforts, production schedule adjustments and product redesigns. The availability of components improved through 2023 and did not have a significant impact to results in 2024.

Industry Conditions

The capital goods industries in general, and the Hydraulics and Electronics segments specifically, are subject to economic cycles. We utilize industry trend reports from various sources, as well as feedback from customers and distributors, to evaluate economic trends. We also rely on global government statistics such as Gross Domestic Product and Purchasing Managers Index to understand higher level economic conditions.

Hydraulics

According to the National Fluid Power Association (the fluid power industry’s trade association in the U.S.), the U.S. index of shipments of hydraulic products decreased 15% in 2024, after decreasing 4% in 2023 and increasing 20% in 2022. In Europe, the CEMA Business Barometer reported in January 2025 that the general business climate index for the European agricultural machinery industry has risen further but continues in negative territory. The majority of survey participants expect incoming orders to rise in the coming six months from their current depressed levels and the confidence index for almost all European markets has improved. CEMA further reported that the direct customers of the manufacturers, the dealers, have still not been able to pass on all orders to the end customers and the dealer stocks continue with above-average levels in almost all European markets, though a considerable improvement can be seen compared to previous months. The Committee for European Construction Equipment business climate index bounced back slightly in later part of 2024 after consecutive months of decline. They reported that sales in the European market are still declining but the momentum decelerates. The expectations for next year are pretty diverse across the industry, as one third of companies anticipate a return to growth while almost the same share expects more declines to come.

Electronics

The Federal Reserve’s Industrial Production Index, which measures the real output of all relevant establishments located in the U.S., reports production of semiconductors and other electronics components declined through 2024 with an uptick at the end of December 2024. The Institute of Printed Circuits Association (“IPC”) reported that North American printed circuit board (“PCB”) shipments decreased in December 2024 by 0.3% against the same month last year following a year over year increase in November of 4.7% and a year over year decline in October of 11.1%. PCB bookings increased year over year in the last quarter with December up 59.6%, November up 29.1% and October up 3.5%. The IPC also reported that North American electronics manufacturing services (“EMS”) shipments decreased 7.8% in December 2024 compared to the same month last year following year over year increases in October and November of 14.7% and 10.6%, respectively. EMS bookings also increased year over year in the last quarter with December up 28%, November up 8.1% and October up 6.6%. The significant year over year increase in both PCB and EMS bookings were attributed to orders being pulled forward due to tariff uncertainties.

Restructuring Activities

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During 2024, we incurred $5.2 of costs related to our restructuring activities, down from $12.1 in 2023. Restructuring activities include activities within our Hydraulics segment related to the creation of our two new Regional Operational Centers of Excellence ("CoE") which are nearing completion. We also continue to add capabilities and activities to our recently expanded Tijuana, Mexico facility to support our Electronics segment. Initial efforts have focused on circuit board assembly and wire harness production. We have also recently initiated some restructuring activities to better optimize our European regional operations. We are transitioning some manufacturing of manifolds and integrated package assembly to our Roncolo, Italy location. These activities include in part the transferring of equipment and operations between facilities. The restructuring costs are comprised of non-recurring severance and termination benefits of $2.5 and $2.7 of travel and other expenses. The restructuring plans are expected to improve the global cost structure of the business.

Executive Officer Transition

In July 2024, the Board of Directors terminated the former President and Chief Executive Officer, Josef Matosevic. Sean Bagan was immediately appointed to serve as Interim President and Chief Executive Officer in addition to his role as Chief Financial Officer, and Philippe Lemaitre as Executive Chairman in addition to his role as Chairman, while the search for a replacement was underway. On January 6, 2025, the Company announced that the Board of Directors of the Company promoted Sean Bagan to President and Chief Executive Officer of the Company, effective January 6, 2025. He will continue to serve as Chief Financial Officer while the Company conducts a search process to identify a permanent Chief Financial Officer. In connection with Mr. Bagan’s appointment, Chairman Philippe Lemaitre, serving as Executive Chairman, resumed his role as Non-Executive Chairman.

2024 Results and Comparison of Years Ended December 28, 2024 and December 30, 2023

(In millions, except per share data)

The following is a discussion of our results of operations and liquidity and capital resources for the year ended December 28, 2024; comparisons are with the corresponding reporting period of 2023, unless otherwise noted.

The following table presents our consolidated results of operations:

Consolidated net sales for the 2024 year declined $29.7, 3.6%. We experienced organic net sales decline of $34.7 which was partially offset by sales from acquisitions totaling $5.0. Sales were impacted most by reduced demand for products in our agriculture, mobile, industrial and recreational marine markets. These end markets experienced lower year over year demand with declines persisting through the fourth quarter. Sales to the Health and Wellness end market were up from the prior year almost 20%. As previously noted, during the Covid-19 pandemic consumers significantly invested in health and leisure products, accelerating sales in that end market. This was followed by a sharp decline in 2023. 2024 was more in line with pre-pandemic demand levels. In 2024, consolidated net sales were down in the Americas and EMEA, but up in APAC which was primarily driven by increased sales to China. There was an unfavorable impact of $0.7 on consolidated net sales from changes in foreign currency exchange rates during the year.

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Gross profit declined $9.4, 3.6%, in 2024 driven by lower volume and higher wage and benefit costs of $6.1M partially offset by lower restructuring costs of $3.0M and lower material costs. Gross margin was flat year-over-year. Material costs as a percentage of sales, excluding targeted pricing benefits and acquisition-related sales, were down slightly year-over-year on a consolidated basis. This was offset by lower fixed overhead costs leverage on lower volume and cost impacts noted above. Changes in foreign currency exchange rates compared to 2023 reduced gross profit by $0.1.

Operating income as a percentage of sales increased 60 basis points to 10.2% in 2024 compared with the prior year period. Operating margin was favorably impacted during 2024 most significantly from lower payroll and benefit costs compared with the prior year period, which included a $5.5 reversal of unvested stock compensation in connection with the officer transition in July 2024 and lower selling, engineering and administrative ("SEA") restructuring costs of $3.9. Additionally, M&A and Integration SEA costs in 2024 were down $3.3 in 2024. These were partially offset by an increase in research and development costs of $0.9.

Net income and earnings per share (“EPS”) were favorably impacted by a contingent gain of $3.8 related to the insurance reimbursement for business interruption losses incurred in the third quarter of 2023 at a manufacturing location in Italy. They were unfavorably impacted by foreign currency transaction losses of $1.3 in 2024 compared to a loss of $0.6 in 2023. There was a slight decrease in tax expense of $0.2 and an increase in interest expense of $2.6 compared to 2023.

Segment Results

Hydraulics

The following table presents the results of operations for the Hydraulics segment:

Net sales for the Hydraulics segment declined by $28.6, 5.1%. We experienced organic net sales decline of $30.5, 5.4%, as acquisition sales only impacted results by $1.9. Net Sales declined in 2024 due to decreased demand in the Americas and EMEA regions and significant declines in the agricultural, mobile and industrial end markets. Sales to APAC grew from prior year, primarily driven by sales to China and Australia. Discrete impacts to our organic sales included nominal favorable pricing changes of $2.2, 0.4%, and an unfavorable change in foreign currency exchange rates of $0.5, 0.1%.

The following table presents net sales based on the geographic region of the sale for the Hydraulics segment:

In 2024, we continued and are nearing completion of our restructuring activities within our Hydraulics segment related to the creation of our two new regional operational Centers of Excellence. We also initiated some restructuring activities to better optimize our European regional operations. We incurred $4.5 of restructuring costs related to these activities including labor, travel and other expenses associated with the manufacturing relocation. $3.3 of the costs are included in cost of goods sold and $1.2 are reflected in SEA expenses.

During 2024, gross profit declined $16.0, 8.8%, from lower volume and higher direct labor costs. Gross margin declined by 120 basis points primarily due to lower fixed overhead costs leverage on lower volume and sales mix. Material costs as a percentage of sales were relatively flat, excluding pricing changes and acquisition-related sales. Changes in foreign currency exchange rates had an unfavorable impact of $0.1.

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Operating income as a percentage of sales decreased 40 basis points to 16.1%. SEA expenses decreased $9.1, 10.3%, mainly due to lower labor and benefit costs, which includes a $3.7 reversal of unvested stock compensation in connection with the officer transition in July 2024, a reduction in research and development costs of $0.6 and a reduction in travel, professional services and other discretionary spend. SEA as a percent of sales decreased 80 basis points to 14.8% in 2024.

In the third quarter of 2023, the Company experienced aggregate losses related to a fire and a weather-related incident at one of its manufacturing locations in Italy resulting in the shut-down of operations for a period of time and disruption in production as recovery efforts ensued. Impacted operations were restored. At the end of 2024 we recorded a contingent gain related to the open insurance claims. The total reimbursement recorded was $9.1, of which $5.3 was offset against actual costs as a result of the incident and the remaining $3.8 was recorded as a gain included in Other Income. The reimbursement payments have been collected in 2025, with $1.1 million outstanding to be collected.

In October 2024, the corporate headquarters and Hydraulics segment operations located in Sarasota, Florida were impacted by Hurricane Milton. Operations were impacted for eighteen shifts leading up to and following the storm. Actual costs for cleanup, repair and labor related to the Hydraulics segment were $1.2. There were no insurance reimbursements received nor are expected to be received for this event.

Electronics

The following table presents the results of operations for the Electronics segment:

Net sales for the Electronics segment declined by $1.1, 0.4%. We experienced organic net sales decline of $4.2, 1.6%, which was partially offset by acquisition sales of $3.1. Organic sales declined in 2024 from decreased demand in the America’s region within several of our end markets including recreational, industrial and mobile. Health and wellness increased year over year and almost offset the losses in the other end markets. The APAC region increased driven by a significant increase in sales to China. Sales in the EMEA region were relatively flat. Discrete impacts to our organic sales included pricing changes that were favorable by $2.8, 1.0%, and unfavorable changes in foreign currency exchange rates of $0.2, 0.1%.

The following table presents net sales based on the geographic region of the sale for the Electronics segment:

In 2024, we continued and are nearing completion of our restructuring activities within our Electronics segment to shift product lines to the expanded facility in Tijuana and to adjust our labor base in line with current demand levels. We incurred $0.7 of restructuring costs including labor, travel and other expenses associated with the manufacturing relocation. $0.1 of the costs are included in cost of goods sold and $0.6 are reflected in SEA expenses.

During 2024, gross profit increased $6.6, 8.3%, primarily due to the contribution from acquisition revenues, pricing, and lower material costs. Gross margin for 2024 increased by 260 basis points primarily from lower material costs offset by the impact of a higher mix of revenue in products with a lower margin profile. Material costs as a percentage of sales decreased by 330 basis points, excluding pricing changes and acquisition-related sales.

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Operating income as a percentage of sales decreased 180 basis points to 11.0%. SEA expenses increased $1.7, 3.1%, in 2024 primarily from acquisitions, an increase in research and development costs of $1.7, which were partially offset by the benefit of a $1.8 reversal of unvested stock compensation in connection with the officer transition in July 2024. SEA as a percent of sales increased 70 basis points to 21.2% in 2024 from 20.5% in 2023, reflecting the impact of acquisitions and increased costs referenced above.

Corporate and Other

Certain costs are excluded from business segment results as they are not used in evaluating the results of, or allocating resources to, our operating segments. For the year ended December 28, 2024, these costs totaled $34.2 and included amortization of acquisition-related intangible assets of $31.5, $1.9 related to officer transition costs and $0.8 related to other costs which was primarily acquisition and integration related activities.

For the year ended December 30, 2023, these costs totaled $38.1 and included amortization of acquisition-related intangible assets of $32.9, $4.0 related to other acquisition and integration activities and $1.2 of officer transition costs.

Interest Expense, net

Net interest expense increased $2.6 during 2024 to $33.8 compared with $31.2 in 2023. The change is attributable to higher average debt levels during 2024 and higher interest rates. Average net debt increased by $1.5 during 2024 to $448.9.

Income Taxes

The provision for income taxes for the year ended December 28, 2024, was 22.8% of pretax income compared with 23.8% for the year ended December 30, 2023. The difference relates principally to a shift in the mix of the company's worldwide income and decrease in valuation allowance established. The effective rate typically fluctuates relative to the levels of income and different tax rates in effect from year to year among the countries in which we sell our products.

The Organization for Economic Cooperation and Development (“OECD”), under its Pillar Two initiative, recently has proposed a set of Global Anti-Base Erosion (“GloBE”) rules to impose a minimum tax on income earned by multinational enterprises (“MNE”). Specifically, the GloBE rules impose a minimum tax of 15 percent on MNE income that arises in each participating jurisdiction. Several countries, including the UK and EU member states, have agreed to adopt the OECD’s minimum tax rules and several countries, including the UK, have already implemented these rules.

On December 20, 2022, the OECD published Pillar Two guidance on safe harbors and penalty relief (the “Safe Harbor Guidance”). The Safe Harbor Guidance includes a Transitional Country-by-Country Report (“CbCR”) Safe Harbor, which would deem a MNE’s top-up tax for a jurisdiction to be zero and would allow the MNE to avoid undertaking detailed GloBE calculations in respect of that jurisdiction during the Transition Period if it can demonstrate one of the three transitional tests.

The Helios Technologies Inc Group is a MNE group that is within the scope and subject to the GloBE rules. The United States has not currently made any public announcement regarding implementation of Pillar Two Framework.

The company continues to evaluate the impact of Pillar Two and application of safe harbors. For the year ended December 28, 2024, there are no impacts to income tax expense related to Pillar Two. The company does not expect it to have a material impact in 2025 to their effective tax rate.

As of December 28, 2024, the Company had approximately $37.1 million of undistributed earnings of its non-U.S. subsidiaries for which it has not provided for non-U.S. withholding taxes and state taxes because such earnings are intended to be reinvested indefinitely in international operations.

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2023 Results and Comparison of Years Ended December 30, 2023 and December 31, 2022

For the discussion and analysis of our 2023 results compared with our 2022 results, refer to our Annual Report on Form 10-K for the fiscal year ended December 30, 2023, filed with the SEC on February 27, 2024. The discussion is incorporated herein by reference.

Liquidity and Capital Resources

Historically, our primary source of capital has been cash generated from operations. We have also used borrowings on our credit facilities to fund acquisitions. During 2024, net cash provided by operating activities totaled $122.1 and as of December 28, 2024, we had $44.1 of cash on hand and $352.4 of available credit on our revolving credit facilities. At year end 2024, approximately half of the cash on hand was held in institutions in APAC, approximately 40% was held in institutions in EMEA, and the remainder was held in institutions in the Americas. We also have a $400.0 accordion feature available on our credit facility, which is subject to certain pro forma compliance requirements and is intended to support potential future acquisitions.

Our principal uses of cash have been paying operating expenses, making capital expenditures, servicing debt, making acquisition-related payments and paying dividends to shareholders.

We believe that cash generated from operations and our borrowing availability under our credit facilities will be sufficient to satisfy our operating expenses and capital expenditures for the foreseeable future. In the event that economic conditions were to severely worsen for a protracted period of time, we would have several options available to ensure liquidity in addition to increased borrowing. Capital expenditures could be postponed since they primarily pertain to long-term improvements in operations, operating expense reductions could be made and the dividend to shareholders could be reduced or suspended.

Cash flows

The following table summarizes our cash flows for the periods:

Cash on hand increased $11.7 to $44.1 at the end of 2024. Cash and cash equivalents were unfavorably impacted by changes in exchange rates by $1.7 and favorably impacted by changes in exchange rates by $0.8 during the years ended December 28, 2024, and December 30, 2023, respectively. Cash balances on hand are a result of our cash management strategy, which focuses on maintaining sufficient cash to fund operations while reinvesting cash in the Company and also paying down borrowings on our credit facilities.

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Operating activities

Net cash from operations totaled $122.1 in 2024, an increase of $38.2, 45.5%, compared with the prior year. Cash earnings, calculated as net income plus adjustments to reconcile net income to net cash provided by operating activities, excluding changes in net operating assets and liabilities, decreased by $1.0 compared to the prior year. However, changes in net operating assets and liabilities increased cash by $39.2 compared to 2023, primarily from reduction in inventories. Reductions in inventory, net of acquisitions, increased cash by $19.4 in 2024 compared with a decrease in cash by $17.9 in 2023. Inventory on hand as of December 28, 2024, decreased by $25.0, 11.6%, compared to the 2023 year end. The decrease is driven primarily by the execution of management's inventory reduction efforts and improved inventory management in response to lower sales. Days of inventory on hand increased to 134 days for the 2024 year, compared with 130 days during the 2023 year. Changes in accounts receivable, net of acquisitions, increased cash by $7.3 and $16.3 in 2024 and 2023, respectively. Days sales outstanding for the 2024 year decreased slightly to 47 days from 50 days during 2023, as our collection patterns remain consistent with the prior year. Changes in accounts payable, net of acquisitions, decreased cash by $11.8 and $5.2 in 2024 and 2023, respectively. Days payables outstanding for the 2024 year decreased to 37 days from 45 days during 2023.

Investing activities

Cash used in investing activities totaled $30.3 in 2024, a decrease of $123.6, 80.3%, compared with the prior year. The decrease in acquisition-related payments accounted for $114.2 of the fluctuation due to no acquisition-related activity in 2024. Capital expenditures were $27.0 during 2024, $7.3, or 21.3%, lower than the prior year primarily from cost deferral initiatives in 2024. Capital expenditures for 2025 are forecasted to be approximately 3.0%-4% of sales for improvements to manufacturing technology and maintaining and replacing existing machine capabilities.

Financing activities

Net cash used in financing activities totaled $78.4 in 2024, compared with net cash provided by financing activities of $57.9 in 2023. In 2024, repayments, net of borrowings, totaled $68.0. Cash paid for acquisitions in 2023 was primarily financed with borrowings on our credit facility. Borrowings, net of repayments, totaled $75.7 in 2023.

Borrowings on our term loans and revolving credit facilities as of December 28, 2024, totaled $300.3 and $150.3, respectively. See Note 10 of the Notes to the Consolidated Financial Statements included in this Annual Report for additional information regarding our credit facilities.

In connection with the debt refinancing in June 2024, while the term loan credit facility aggregate principle amount of $300.0 remained unchanged, the cash flow activity reflects repayments and borrowings on the non-revolving debt that were direct results of the refinancing. The company also incurred $3.1 of debt issuance costs in connection with the debt refinancing. These costs are captured within the Other Financing Activities caption in the Statement of Cash Flows. Additionally in June 2024, the Company received $7.1 in proceeds in connection with the termination of the interest rate swaps.

In May 2023, we entered into an incremental facility amendment to our credit agreement with PNC Bank, National Association, as administrative agent, and various lenders party thereto. With the amendment we incurred a new term loan with an aggregate principal amount of $150.0 for which the proceeds were used to repay outstanding balances on our revolving credit facility.

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On June 25, 2024, the Company amended and restated its credit agreement (the “Third Amended and Restated Credit Agreement”) with PNC Bank, National Association, as administrative agent, and the lenders party thereto. The amendment extended the debt maturity for five years and increased the Company’s revolving credit facility (the “Revolving Credit Facility) to $500.0, with the aggregate principle amount of the term loan credit facility (the “Term Loan Facility”) remaining at $300.0. The amendment also revised the accordion feature to permit an increase of up to an additional $400.0. Borrowings under the line of credit bear interest at defined rates plus an applicable margin based on the Company’s leverage ratio. Scheduled principal payments under the Term Loan Facility are payable in quarterly installments beginning on September 28, 2024 and continuing on the last day of each following fiscal quarter, beginning at $3.75 before increasing to $5.6 in June 2026 and $7.5 in June 2028. All remaining principal and unpaid accrued interest are due on the Term Loan Facility maturity date, which is June 25, 2029.

In May 2024, $0.5 was paid to the former owners of Balboa Water Group in connection with payment due on the contingent consideration liability. The contingent consideration liability was revalued and final payment is due in 2025.

We have historically declared regular quarterly dividends to shareholders of $0.09 per share. We paid dividends totaling $11.9 and $11.8 for the years ended December 28, 2024 and December 30, 2023, respectively. The declaration and payment of future dividends is subject to the sole discretion of the Board of Directors, and any determination as to the payment of future dividends will depend upon our profitability, financial condition, capital needs, acquisition opportunities, future prospects and other factors deemed pertinent by the Board of Directors.

Contractual obligations

Credit facilities

Information on our credit facilities, including future maturities, is presented in Note 10 of the Notes to the Consolidated Financial Statements included in this Annual Report. Our revolving credit facility with PNC Bank matures and is payable in full in June 2029; however, we may make earlier payments. Our term loan with PNC Bank is payable in quarterly installments of $3.8 million through March 2026, quarterly installments of $5.6 million through March 2028 and quarterly installments of $7.5 million thereafter through the maturity date of June 2029, at which time the remaining balance will be due in full.

Interest rates on our credit facilities range from 4.9% to 7.2% as of December 28, 2024. Future interest payments are estimated to total $112.2, with annual payments ranging from $10.8 to $27.7 payable through the last maturity date of June 2029. Future payments assume the current interest rate environment, current currency exchange rates, future required payments on term loans and revolver borrowings consistent with December 28, 2024 debt levels. Future payments do not include an estimate of impacts from our derivative instruments.

Contingent consideration payments

Our contingent consideration liabilities total $0.4 as of December 28, 2024. The balance represents the fair value estimate of contractual contingent payment related to our acquisition of Balboa Water Group, which is payable in 2025.

Supplier purchases

We regularly place purchase orders with our suppliers for inventory and capital expenditures to be used in the ordinary course of business. Open purchase orders as of December 28, 2024 total $66.1 for purchases expected in 2025 and $0.4 for purchases expected in 2026.

Building purchase commitment

The Company is negotiating a lease-to-buy agreement for the purchase of a building with the option to purchase the building at any time during the lease period. Under the draft agreement, the company would commit to purchasing the building at the end of the 6-year lease term. The expected purchase price is €26.7; however, the actual purchase price will be reduced by 60% of the payments made during the lease term.

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Leases

We regularly enter into operating lease agreements for the use of machinery, equipment, vehicles, buildings and office space. Future maturities of our operating lease liabilities are presented in Note 7 of the Notes to the Consolidated Financial Statements included in this Annual Report.

Critical Accounting Policies and Estimates

We prepare our Consolidated Financial Statements in conformity with U.S. GAAP, which requires management to make certain estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. The following policies are considered by management to be the most critical in understanding the judgments, estimates and assumptions that are involved in the preparation of our Consolidated Financial Statements.

Business Combinations

Business combinations are accounted for under the acquisition method of accounting, which requires recognition separately from goodwill, the assets acquired and the liabilities assumed at their acquisition date fair values. Assigning fair market values to the assets acquired and liabilities assumed at the date of an acquisition requires knowledge of current market values, and the values of assets in use, and often requires the application of judgment regarding estimates and assumptions. While the ultimate responsibility resides with management, for certain acquisitions we retain the services of certified valuation specialists to assist with assigning estimated values to certain acquired assets and assumed liabilities, including intangible assets and tangible long-lived assets. Acquired intangible assets, excluding goodwill, are valued using various methodologies such as the discounted cash flow method, which is based on future cash flows specific to the type of intangible asset purchased and the relief from royalty method, which is based on the present value of savings resulting from the right to manufacture or sell products that incorporate the intangible asset without having to pay a license for its use. These methodologies incorporate various estimates and assumptions, the most significant being estimated royalty rates, projected revenue growth rates, profit margins and forecasted cash flows based on the discount rate.

Intangible assets consist primarily of customer relationships, technology, trade names and brands and supply agreements. Amortization is on a straight-line basis over their estimated useful lives and the amortization is reflected in the Consolidated Statements of Operations. The useful lives used are as follows: Customer Relationships - 8 to 26 years; Trade Names and Brands - 10 to 20 years; Technology - 5 to 13 years; and Supply Agreements - 10 years. Intangible assets are tested for impairment if certain circumstances arise that would indicate the carrying amount of the assets may not be recoverable. Such circumstances can include, but are not limited to, a decrease in market price, economic decline, changes in the market, change in business operations or plans for disposition. The assessment of fair value for impairment purposes requires significant judgment by management, which could be negatively impacted by economic decline, market deterioration and changes in other market conditions. Additional information about intangible assets, including the gross and net carrying values for the reported periods and historical and future estimated amortization expense is presented in Note 8 of the Notes to the Consolidated Financial Statements included in this Annual Report. Additional information about our acquisitions, including acquired intangible assets deemed material to the Company’s financial results, is presented in Note 3 of the Notes to the Consolidated Financial Statements included in this Annual Report.

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Goodwill

Goodwill represents the excess of the purchase price of an acquisition over the fair value of the net assets acquired. We test goodwill for impairment at the reporting unit level, as of the third quarter period end date, on an annual basis and between annual tests whenever events or circumstances indicate the carrying value of a reporting unit may exceed its fair value. Examples of such circumstances could include, but are not limited to, a significant loss of market share, significant decline in operating results, change in management strategy or operations, economic decline, and other such significant disruptions to the business. The carrying value of assets is calculated at the reporting unit level. An impairment loss is recorded to the extent that the fair value of the goodwill within the reporting unit is less than its carrying value.

There are multiple steps in our process for testing goodwill impairment. The first step is identification of our operating segments, followed by the identification of the reporting units, such that the reporting unit has discrete financial information, its operating results are reviewed regularly by management, and its economic characteristics are different from the economic characteristics of the other components of the operating segment., As part of the annual test of goodwill impairment the Company considers economic factors and current business operations when assessing the reporting unit structures for the purposes of goodwill impairment testing. The reporting units comprised of our four prominent businesses and the 2023 acquisition of i3.

In certain circumstances the Company may elect to test goodwill using a qualitative assessment, assessing whether it is more likely than not that the fair value of the reporting unit is less than the carrying value. More often the Company will test goodwill using the income based and market based valuation methods, as quoted market prices are not available for all reporting units. When possible, we generally use a combination of market and income approach methodologies to estimate the fair value of our reporting units. The assessment of fair value for impairment purposes requires significant judgment by management. Management’s assumptions include projected future performance, expected future costs, expected new product releases and expected future economic and market conditions (i.e. inflation, tax rates, end-market growth or decline, and expected market share performance). If these assumptions and estimates are not met or operations are impacted by other factors the reporting units could be subject to goodwill impairment.

The income approach is generally based on a discounted cash flow analysis, which estimates the present value of the projected free cash flows to be generated by the reporting unit. Assumptions used in the analysis include estimated future revenues and expenses, working capital, capital expenditures and other variables. Assumptions made for future cash flows are developed based on consideration of current and future economic conditions, recent and expected sales trends, planned timing of product launches and other relevant variables. Each reporting unit regularly prepares discrete operating forecasts and long range plans and uses these forecasts as the basis for the assumptions in the discounted cash flow analysis. Within the discounted cash flow models, the Company uses a discount rate, commensurate with its cost of capital but adjusted for inherent business risks, and an appropriate terminal growth factor.

The market approach estimates the value of reporting units by comparing to guideline public companies or guideline transactions. Various valuation multiples of companies that are economically and operationally similar are used as data points for selecting multiples for the reporting units, which are deemed to be market-adjusted multiples based on key data points for guideline public companies. Changes in assumptions or estimates could materially affect the estimated fair value of our reporting units and the potential for impairment. We also reconcile the estimated aggregate fair value of our reporting units resulting from these procedures to our overall market capitalization.

The Company completed its annual goodwill impairment testing for 2024, 2023, and 2022, and determined that the carrying amount of goodwill for each reporting unit was not impaired. In addition, in management’s assessment of reporting units for GWI testing, it was determined that the two prominent Electronics businesses share very similar economic characteristics, are operationally interdepended, and should be aggregated and tested as a single reporting unit. The test for goodwill impairment was performed for each business and for the consolidated reporting unit. Neither test indicated any impairment.

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Given the relatively small excess fair value over the carrying value of the i3 reporting unit in 2024, less than 3%, it is at risk for possible future impairment. This goodwill value of $25.9, assumed in the May 2023 acquisition of i3, is 5.2% of the $498.9 of Goodwill as of December 28, 2024. Management is monitoring this closely but believes in the benefits that this acquisition and specifically the Cygnus software will bring to the Company in the coming years. However, if the expected benefits do not materialize due to poor economic conditions, missed operational objectives, or other such factors impacting Management’s assumptions, there could future impairment of the goodwill.

A third party was used to assist in the valuation and testing of the fair value of the reporting units. The third party provided estimates such as risk premiums, select multiples and discount rates, used in conjunction with Management’s estimates and assumptions to calculate the fair value of the reporting unit. These estimates require significant judgment. If there is economic decline, expectations for growth are not met, product launches are delayed, there is a change to management’s operating outlook, operational restructuring, or any other significant change to the assumptions, estimates or other risks previously mentioned, the reporting units could be subject to impairment.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those 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. To the extent the Company determines that it is more likely than not a deferred income tax asset will not be realized, a valuation allowance is established. The recoverability analysis of the deferred income tax assets and the related valuation allowances requires significant judgment and relies on estimates. At December 28, 2024, valuation allowances against deferred tax assets were $2.3 million. Refer to Note 12 of the Notes to the Consolidated Financial Statements included in this Annual Report for additional information on the composition of these valuation allowances.

Our annual tax rate fluctuates based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective government taxing authorities. Significant judgment is required in determining our tax expense and in evaluating our tax positions, including evaluating uncertainties. We review our tax positions quarterly and adjust the balances as new information becomes available. Indefinite reinvestment is determined by management’s judgment about, and intentions concerning, our future operations.

We recognize and measure uncertain tax positions in accordance with ASC 740. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. We adjust these reserves, as well as the related interest and penalties, where appropriate in light of changing facts and circumstances. Settlement of any particular position could require the use of cash. We recognize interest and penalties, if any, related to unrecognized tax benefits in income tax expense.

See Note 12 of the Notes to the Consolidated Financial Statements included in this Annual Report for income tax amounts, including reserves.

Off Balance Sheet Arrangements

We do not engage in any off balance sheet financing arrangements. In particular, we do not have any material interest in variable interest entities, which include special purpose entities and structured finance entities.

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

The operating results of the Hydraulics and Electronics segments included in Management’s Discussion and Analysis of Financial Condition and Results of Operations are presented on a basis consistent with our internal management reporting. Segment information included in Note 16 of the Notes to the Consolidated Financial Statements included in this Annual Report is also presented on this basis. All differences between our internal management reporting basis and accounting principles generally accepted in the U.S. (“U.S. GAAP”), specifically the allocation of certain corporate and acquisition-related costs, are included in Corporate and Other.

Overview

We are a global leader in highly engineered motion control and electronic controls technology for diverse end markets, including construction, material handling, agriculture, industrial, mobile, energy, recreational vehicles, marine and health and wellness.

We operate under two business segments: Hydraulics and Electronics. The Hydraulics segment designs and manufactures hydraulic motion control and fluid conveyance technology products, including cartridge valves, manifolds, quick release couplings as well as engineers hydraulic solutions and in some cases complete systems. The Electronics segment designs and manufactures customized electronic controls systems, displays, wire harnesses, and software solutions for a variety of end markets.

During 2021, we augmented our strategy to transform our business from a holding company to a global integrated operating company. At that same time, we introduced the framework of the Helios Business System, “HBS” (pictured in Item 1 of Part 1), which is at the heart of all we do. We are accomplishing this transformation into a global integrated operating company by leveraging sales, marketing, innovation, customer relationships and operational excellence across all our businesses. Our progress to date, through a very complex macro operating environment, is a direct reflection of the commitment of our talented workforce executing our augmented strategy.

Acquisitions

Our acquisition activity, driven by our strategic vision, has enabled us to diversify our product offerings and the markets we serve and expand our geographic presence. Prior to 2016, we operated primarily in the hydraulics market with a small presence in electronics.

In January 2021, we acquired the assets of BJN Technologies, LLC, an innovative engineering solutions provider that was founded in 2014. With the acquisition, we formed the Helios Center of Engineering Excellence to centralize our innovation and technology advancements to better leverage existing talents across the electronics segment initially, and then throughout all of Helios.

In July 2021, we completed another flywheel acquisition of NEM S.r.l., an innovative hydraulic solutions company providing customized material handling, construction, industrial vehicle and agricultural applications to its global customer base, predominantly in Europe and Asia. NEM enhances the Helios electro-hydraulic product offering, provides geographic expansion and adds scale to address new markets.

In October 2021, we completed the acquisition of Joyonway, a developer of control panels, software, systems and accessories for the health and wellness industry. Joyonway operates from two locations in China, Shenzhen and Dongguan, both of which are in the hub of electronics and software development in China and give us a foothold for electronics manufacturing in Asia.

In July 2022, we completed the acquisition of the assets of Taimi R&D, Inc., a Canadian manufacturer of innovative hydraulic components that offers ball-less design swivel products, which improve hydraulic reliability of equipment, increase the service life of components and help protect the environment by reduced leakage. Taimi brings a differentiated, yet complementary product line to our hydraulics platform as well as strong engineering breadth.

In September 2022, we completed another flywheel acquisition of Daman Products Company, headquartered in Mishawaka, Indiana. Daman is a leading designer and manufacturer of standard and custom precision hydraulic manifolds and other fluid conveyance products for its customer base, predominantly in North America. The acquisition of Daman

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expands the Company's technologies and markets and provides an opportunity to produce integrated package offerings with multiple Helios brands.

In January 2023, we completed the acquisition of Schultes Precision Manufacturing, Inc. Schultes is a highly trusted specialist in manufacturing precision machined components and assemblies for customers requiring very tight tolerances, superior quality, and exceptional value-added manufacturing processes. Currently serving the hydraulic, aerospace, communication, food services, medical device, and dental industries, Schultes brings the manufacturing quality, reliability, and responsiveness critical to its customers’ success. Schultes provides additional manufacturing know-how and expands our business into new end markets with attractive secular tailwinds.

In May 2023, we completed the acquisition of i3 Product Development. i3 is a custom engineering services firm, with over 55 engineers specializing in electronics, mechanical, industrial, embedded and software engineering. i3 specializes in working to transform customer’s ideas into industrial design solutions through rapid prototyping and creating 3D models in-house. Their solutions are used across many sectors, including medical, off-highway, recreational and commercial marine, power sports, health and wellness, agriculture, consumer goods, industrial, sports and fitness.

Global Economic Conditions

Geo-Political Conflict

We continue to monitor the ongoing conflicts between Russia and Ukraine and the Israel-Hamas war and evaluate the broader economic impact those conflicts could have on our operations, supply channels and the operations of our partners and customers. We do not have operations in these regions at this time and those conflicts have not and are not expected to have a material impact on our financial condition or results. Refer to Item 1A Risk Factors of this Annual Report for additional discussion about geo-political risks.

COVID-19 Pandemic

In the first half of 2022, we experienced mild impacts from the pandemic. At the beginning of the second quarter our locations in China began to shut down periodically due to regulatory lockdown measures associated with a COVID-19 outbreak. The shutdown of our locations and our customers' locations impacted operations and sales through May with recovery occurring in June as the lockdowns were lifted. We also faced disruption to our workforce from the pandemic. While the impact was not significant, the absenteeism caused labor inefficiencies in production. Additionally, in certain locations we faced pressure from competitive labor markets. Since the first half of 2022, there have been no COVID-related shutdowns or other significant new disruption to our business from the pandemic.

Throughout 2022, and continuing into 2023, we faced constraints related to sourcing certain electronic and other components, which originated from the high demand for these products caused by the pandemic. We were able to mitigate some of the impact with our procurement efforts, production schedule adjustments and product redesigns. The availability of components improved as 2023 progressed.

Demand in the health and wellness market was favorably impacted by the pandemic in 2020 and 2021, as consumers invested in leisure products and activities. However, during 2022, we experienced a sharp decline in sales in this end market as demand declined and inventory levels in the channel increased. By the second half of 2023, inventory levels in the market began to normalize, and we saw an uptick in demand as we exited the year.

Refer to Item 1A Risk Factors of this Annual Report for additional COVID-19 related discussion.

Industry Conditions

The capital goods industries in general, and the Hydraulics and Electronics segments specifically, are subject to economic cycles. We utilize industry trend reports from various sources, as well as feedback from customers and distributors, to evaluate economic trends. We also rely on global government statistics such as Gross Domestic Product and Purchasing Managers Index to understand higher level economic conditions.

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Hydraulics

According to the National Fluid Power Association (the fluid power industry’s trade association in the U.S.), the U.S. index of shipments of hydraulic products decreased 4% in 2023, after increasing 20% in 2022 and increasing 21% in 2021. In Europe, the CEMA Business Barometer reported in January 2024 that the general business climate index for the European agricultural machinery industry has continued its downward slide in the area of deep recession territory. CEMA further reported that the direct customers of the manufacturers, the dealers, are not able to pass on their numerous orders to the end customers. The CECE (Committee for European Construction Equipment) business climate index bounced back slightly in November after seven consecutive months of decline. They reported the favorability was driven by both current business evaluation and future expectations.

Electronics

The Federal Reserve’s Industrial Production Index, which measures the real output of all relevant establishments located in the U.S., reports production of semiconductors and other electronics components met the lowest level in the first quarter of 2023 when compared to the prior two years; however, this improved notably and consistently throughout 2023, to reach the record high in the fourth quarter of 2023 when compared to the prior two years. The Institute of Printed Circuits Association (“IPC”) reported that North American printed circuit board (“PCB”) shipments and bookings decreased in December 2023 by 18.3% and 28.7%, respectively, compared with the same month last year. PCB shipments increased and bookings decreased in December 2023 by 1.0% and 14.1%, respectively, compared with November 2023. The IPC also reported that North American electronics manufacturing services (“EMS”) shipments increased and bookings decreased in December 2023 by 1.3% and 7.0%, respectively when compared with the same month last year. EMS shipments and bookings in December 2023 were up 6.2% and 2.3%, respectively when compared with November 2023.

2023 Results and Comparison of Years Ended December 30, 2023 and December 31, 2022

(In millions, except per share data)

The following is a discussion of our results of operations and liquidity and capital resources for the year ended December 30, 2023; comparisons are with the corresponding reporting period of 2022, unless otherwise noted.

The following table presents our consolidated results of operations:

Consolidated net sales for the 2023 year declined $49.8, 5.6%. We experienced organic net sales decline of $102.6, which was offset partially by sales from acquisitions totaling $52.8. Sales were impacted most by reduced demand for products in our health and wellness end market, which continued to be below the prior year. Sales in this end market were previously strengthened by the pandemic as consumers invested in health and leisure products. Other declines included sales into the industrial, marine and mobile end markets, offset partially by increases in the off-road vehicles end market. Consolidated net sales were down in all regions in the year-to-date period. Year-to-date organic sales were positively impacted by pricing changes of $18.6, 2.1%. Also, there were minimal effects on consolidated net sales from changes in foreign currency exchange rates during the year.

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Gross profit declined $36.8, 12.3%, in 2023 driven by lower volume, different margin profiles of acquired businesses, higher restructuring costs of $4.7, higher wage and benefit costs of $2.4 and unfavorable foreign currency of $0.4, partially offset by pricing adjustments. Material costs as a percentage of sales, excluding pricing changes and acquisition-related sales, was the same year-over-year on a consolidated basis. Gross margin declined by 240 basis points, impacted by lower fixed costs leverage on lower volume and cost impacts noted above. Changes in foreign currency exchange rates compared to 2022 reduced gross profit by $0.4.

During 2023, we incurred $12.1 of costs related to our restructuring activities. In the Hydraulics segment, we executed an operational restructure that involved the creation of our two new regional operational Centers of Excellence. In our Electronics segment, we executed an organizational restructure to shift several product lines to the expanded facility in Tijuana and to adjust our labor base in line with current demand levels. The restructuring costs are comprised of non-recurring severance and termination benefits of $7.8 and $4.3 of travel and other expenses. The restructuring plans are expected to improve the global cost structure of the business.

Operating income as a percentage of sales decreased 5.9 percentage points to 9.6% in 2023 compared with the prior year period. Operating margin was unfavorably impacted during 2023 by different margin profiles of acquired businesses and a $4.8 increase in acquisition-related amortization, primarily from the new intangibles added during the first half of the 2023 for the Schultes and i3 acquisitions. These negative impacts were compounded by higher restructuring costs included in Selling, engineering and administrative (“SEA”) expenses of $2.2 and the gross margin level changes. However, these unfavorable impacts were partially offset by lower M&A and integration related costs of $5.3.

Net income and earnings per share (“EPS”) were unfavorably impacted by foreign currency transaction losses of $0.6 in 2023 compared to gains of $0.9 in 2022. The prior year benefited from gains on sale of property, plant and equipment primarily related to restructuring activities totaling $1.8, and the current year benefited from a decrease in tax expense of $11.7 compared to 2022.

Segment Results

Hydraulics

The following table presents the results of operations for the Hydraulics segment:

Net sales for the Hydraulics segment grew by $14.5, 2.6%. We experienced organic net sales decline of $32.5, 5.9%, and acquisition sales totaled $47.0. Organic sales declined in 2023 due to decreased demand in all regions, as well as in several of our end markets including the mobile and industrial equipment markets. Discrete impacts to our organic sales included pricing changes that were favorable by $13.4, 2.4%, and favorable changes in foreign currency exchange rates of $0.3, 0.1%.

The following table presents net sales based on the geographic region of the sale for the Hydraulics segment:

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Regional sales performance in 2023 compared to the prior year was driven by:

Americas - pricing and our recent acquisitions contributed to a 17.5% increase in sales

EMEA - excluding favorable changes in foreign currency rates of $3.3, sales declined $12.2, 6.5%, from softer demand in the region

APAC - excluding unfavorable changes in foreign currency rates of $3.0, sales declined $8.5, 5.1%, from softer demand in the region

In 2023, we continued our restructuring activities within our Hydraulics segment related to the creation of our two new regional operational Centers of Excellence. We incurred $10.2 of restructuring costs including labor, travel and other expenses associated with the manufacturing relocation; $6.0 of the costs are included in cost of goods sold and $4.2 are reflected in SEA expenses.

During 2023, gross profit declined $13.7, 7.0%, from volume while gross margin declined by 340 basis points, primarily from different margin profiles of acquired businesses, $4.9 of increased restructuring costs comprised of labor, travel and other expenses associated with the manufacturing relocation, $0.6 of unfavorable change in foreign currency exchange rates, which were partially offset by pricing amounts noted above. Material costs as a percentage of sales increased by 110 basis points, excluding pricing changes and acquisition-related sales.

Operating income as a percentage of sales decreased 580 basis points to 16.5%. SEA expenses increased $15.7, 21.6%, mainly due to acquisitions and corporate activities. Other increases to SEA were for restructuring costs of $1.3, professional fees of $0.7, R&D costs of $0.7 and travel and marketing costs of $0.6. SEA as a percent of sales increased 240 basis points to 15.6% in 2023, negatively impacted from lost leverage of our fixed costs on the lower sales.

In the third quarter of 2023, the Company experienced aggregate losses related to a fire and a weather-related incident at one of its manufacturing locations in Italy resulting in the shut-down of operations for a period of time and disruption in production as recovery efforts ensued. Impacted operations have been restored. There are insurance claims open related to these incidents and the Company is working closely with the insurance carrier to assess the claims and evaluate potential recoveries. Losses from damage to the building, equipment and supplies have been fully offset by probable insurance recoveries, which represents anticipated insurance proceeds not in excess of the associated losses, for which receipt has been deemed probable. Any recoveries in excess of losses incurred will be recognized when all contingencies related to the claim have been resolved.

Electronics

The following table presents the results of operations for the Electronics segment:

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Net sales for the Electronics segment declined by $64.3, 19.2%. We experienced organic net sales decline of $70.1, 21.0%, which was partially offset by acquisition sales of $5.8. Organic sales declined in 2023 from decreased demand in all regions, as well as in several of our end markets including the health and wellness end market. The marine market also experienced a notable decline; however, this was partially offset by improvement in the mobile and off-road vehicles end markets. Discrete impacts to our organic sales included pricing changes that were favorable by $5.2, 1.6%, partially offset by unfavorable changes in foreign currency exchange rates of $0.2, 0.1%.

The following table presents net sales based on the geographic region of the sale for the Electronics segment:

In 2023, we executed restructuring activities within our Electronics segment to shift product lines to the expanded facility in Tijuana and to adjust our labor base in line with current demand levels. We incurred $1.9 of restructuring costs including labor, travel and other expenses associated with the manufacturing relocation; $0.4 of the costs are included in cost of goods sold and $1.5 are reflected in SEA expenses.

During 2023, gross profit declined $23.1, 22.4%, primarily due to lower sales volume and material cost increases. Gross margin for 2023 declined by 120 basis points primarily from the higher material costs, unfavorable margin profile of acquired businesses, $0.7 of increased restructuring costs comprised of labor, travel and other expenses associated with the manufacturing relocation, partially offset by favorable impacts from changes in foreign currency exchange rates compared to the prior year of $0.1 and the pricing amounts noted above. Material costs as a percentage of sales decreased by 80 basis points, excluding pricing changes and acquisition-related sales.

SEA expenses increased $4.7, 9.3%, in 2023 primarily from acquisitions and wages and benefits of $2.4 for the rolling impact of previous merit increases, market adjustments and new hires for investments in engineering, sales and corporate activities. SEA as a percent of sales increased 5.4 percentage points to 20.5% in 2023 from 15.1% in 2022, negatively impacted by reduced leverage of our fixed costs on the lower sales.

Corporate and Other

Certain costs are excluded from business segment results as they are not used in evaluating the results of, or allocating resources to, our operating segments. For the year ended December 30, 2023, these costs totaled $38.1 for: amortization of acquisition-related intangible assets of $32.9, $4.0 related to other acquisition and integration activities and $1.2 officer transition costs.

For the year ended December 31, 2022, these costs totaled $37.9 for: amortization of acquisition-related intangible assets of $28.1, $9.5 related to other acquisition and integration activities and $0.3 officer transition costs.

Interest Expense, net

Net interest expense increased $14.5 during 2023 to $31.2 compared with $16.7 in 2022. The change is attributable to higher average debt levels during 2023, as borrowings used to fund acquisitions exceeded repayments in addition to higher interest rates when compared to 2022. Average net debt increased by $37.9 during 2023 to $447.4 compared with $409.5 in 2022.

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Income Taxes

The provision for income taxes for the year ended December 30, 2023, was 23.8% of pretax income compared with 19.2% for the year ended December 31, 2022. The difference relates principally to a shift in the mix of the Company's worldwide income and increase in valuation allowance established. The effective rate typically fluctuates relative to the levels of income and different tax rates in effect from year to year among the countries in which we sell our products.

On August 16, 2022, the Inflation Reduction Act was enacted into law, and includes, among other things, a new 15% corporate alternative minimum tax and 1% excise tax on stock repurchases after December 31, 2022. The corporate alternative minimum tax is not expected to have a material impact on current and future financial results due to the Company’s ability to qualify for a safe-harbor exclusion, however we will continue to evaluate its impact in future periods.

The Organization for Economic Cooperation and Development (“OECD”), under its Pillar Two initiative, recently has proposed a set of Global Anti-Base Erosion (“GloBE”) rules to impose a minimum tax on income earned by multinational enterprises (“MNE”). Specifically, the GloBE rules impose a minimum tax of 15 percent on MNE income that arises in each participating jurisdiction. Several countries, including the UK and EU member states, have agreed to adopt the OECD’s minimum tax rules and several countries, including the UK, have already implemented these rules.

On December 20, 2022, the OECD published Pillar Two guidance on safe harbors and penalty relief (the “Safe Harbor Guidance”). The Safe Harbor Guidance includes a Transitional Country-by-Country Report (“CbCR”) Safe Harbor, which would deem a MNE’s top-up tax for a jurisdiction to be zero and would allow the MNE to avoid undertaking detailed GloBE calculations in respect of that jurisdiction during the Transition Period if it can demonstrate one of the three transitional tests.

The Helios Technologies, Inc. Group is a MNE group that is within the scope and subject to the GloBE rules. The United States has not currently made any public announcement regarding implementation of Pillar Two initiative.

The Company continues to evaluate the impact of Pillar Two and application of safe harbors. The Company does not expect it to have a material impact in 2024 to their effective tax rate.

As of December 30, 2023, the Company had approximately $29.3 million of undistributed earnings of its non-U.S. subsidiaries for which it has not provided for non-U.S. withholding taxes and state taxes because such earnings are intended to be reinvested indefinitely in international operations.

2022 Results and Comparison of Years Ended December 31, 2022 and January 1, 2022

For the discussion and analysis of our 2022 results compared with our 2021 results, refer to our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, filed with the SEC on February 28, 2023. The discussion is incorporated herein by reference.

Liquidity and Capital Resources

Historically, our primary source of capital has been cash generated from operations. We also use borrowings on our credit facilities to fund acquisitions. During 2023, net cash provided by operating activities totaled $83.9 and as of December 30, 2023, we had $32.4 of cash on hand and $200.1 of available credit on our revolving credit facilities. At year end 2023, more than half of the cash on hand was held in institutions in APAC, approximately a quarter held in institutions in EMEA, and the remainder held in institutions in the Americas. We also have a $300.0 accordion feature available on our credit facility, which is subject to certain pro forma compliance requirements and is intended to support potential future acquisitions.

Our principal uses of cash have been paying operating expenses, making capital expenditures, servicing debt, making acquisition-related payments and paying dividends to shareholders.

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We believe that cash generated from operations and our borrowing availability under our credit facilities will be sufficient to satisfy our operating expenses and capital expenditures for the foreseeable future. In the event that economic conditions were to severely worsen for a protracted period of time, we would have several options available to ensure liquidity in addition to increased borrowing. Capital expenditures could be postponed since they primarily pertain to long-term improvements in operations, operating expense reductions could be made and the dividend to shareholders could be reduced or suspended.

Cash flows

The following table summarizes our cash flows for the periods:

Cash on hand decreased $11.3 to $32.4 at the end of 2023. Cash and cash equivalents were favorably impacted by changes in exchange rates by $0.8 and $3.0 during the years ended December 30, 2023, and December 31, 2022, respectively. Cash balances on hand are a result of our cash management strategy, which focuses on maintaining sufficient cash to fund operations while reinvesting cash in the Company and also paying down borrowings on our credit facilities.

Operating activities

Net cash from operations totaled $83.9 in 2023, a decrease of $26.0, 23.7%, compared with the prior year. Cash earnings (calculated as net income plus adjustments to reconcile net income to net cash provided by operating activities, excluding changes in net operating assets and liabilities) decreased by $47.4 compared to the prior year. However, changes in net operating assets and liabilities increased cash by $21.4 compared to 2022, primarily from favorable cash flows from AR, inventories and AP. Investments in inventory, net of acquisitions, reduced cash by $17.9 and $27.0 in 2023 and 2022, respectively. Inventory on hand as of December 30, 2023, increased by $23.5, 12.3%, compared to the 2022 year end. The increase is driven primarily by lower volume of sales, temporary build-up due to constrained supply chain environment, and buildup of inventory to support the creation of the Centers of Excellence. Days of inventory on hand increased to 130 days for the 2023 year, compared with 111 days during the 2022 year. Changes in accounts receivable, net of acquisitions, increased cash by $16.3 in 2023 compared with a decrease in cash of $9.1 in 2022, a result of higher sales in the last few months of the 2023 year compared to 2022. Days sales outstanding for the 2023 year decreased slightly to 50 days, from 52 days during 2022, as our collection patterns remain consistent with the prior year.

Investing activities

Cash used in investing activities totaled $153.9 in 2023, an increase of $63.1, 69.5%, compared with the prior year. The increase in acquisition-related payments accounted for $46.9 of the fluctuation. Capital expenditures were $34.3 during 2023, $2.4, or 7.5%, higher than the prior year primarily from investments in machinery and equipment. These increases in cash used were partially offset by $0.3 in proceeds from dispositions of property, plant and equipment, a decrease of $6.9 compared with the prior year, which was inflated by the sale of a building related to our restructuring projects. Capital expenditures for 2024 are forecasted to be approximately 3%-4% of sales, for investments in machinery and equipment for capacity expansion projects, improvements to manufacturing technology and maintaining/replacing existing machine capabilities.

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Financing activities

Net cash provided by financing activities totaled $57.9 in 2023, compared with net cash used in financing activities of $6.9 in 2022. Cash paid for acquisitions in 2023 was primarily financed with borrowings on our credit facility; borrowings, net of repayments, during 2023 totaled $75.7. In 2022, borrowings, net of repayments, totaled $8.0.

Borrowings on our term loans and revolving credit facilities as of December 30, 2023, totaled $322.1 and $203.3, respectively. See Note 10 of the Notes to the Consolidated Financial Statements included in this Annual Report for additional information regarding our credit facilities.

In May 2023, we entered into an incremental facility amendment to our credit agreement with PNC Bank, National Association, as administrative agent, and various lenders party thereto. With the amendment we incurred a new term loan with an aggregate principal amount of $150.0 for which the proceeds were used to repay outstanding balances on our revolving credit facility. The new term loan is payable in full in October 2025 and is not subject to any required repayments prior to that date. As part of the amendment, we continue to have the ability to increase our revolving credit facility or incur a new term loan up to an additional borrowing limit of $300.0.

We have historically declared regular quarterly dividends to shareholders of $0.09 per share. We paid dividends totaling $11.8 and $11.7 for the years ended December 30, 2023 and December 31, 2022, respectively. The declaration and payment of future dividends is subject to the sole discretion of the board of directors, and any determination as to the payment of future dividends will depend upon our profitability, financial condition, capital needs, acquisition opportunities, future prospects and other factors deemed pertinent by the board of directors.

Contractual obligations

Credit facilities

Information on our credit facilities, including future maturities, is presented in Note 10 of the Notes to the Consolidated Financial Statements included in this Annual Report. Our revolving credit facility with PNC Bank matures and is payable in full in October 2025; however, we may make earlier payments. Our term loan with PNC Bank is payable in quarterly installments of $5.0 through the maturity date of October 2025, at which time the remaining balance will be due in full. Our new term loan with PNC Bank is payable in full in October 2025 and is not subject to any required repayments prior to that date.

Interest rates on our credit facilities range from 5.4% to 7.7% as of December 30, 2023. Future interest payments are estimated to total $68.5, with annual payments ranging from $38.1 to $30.2 payable through the last maturity date of June 2026. Future payments assume the current interest rate environment, current currency exchange rates, future required payments on term loans and revolver borrowings consistent with December 30, 2023 debt levels. Future payments do not include an estimate of impacts from our derivative instruments.

Contingent consideration payments

Our contingent consideration liabilities total $0.5 as of December 30, 2023. The balance represents the fair value estimate of contractual contingent payment related to our acquisition of Balboa, which is payable in the last quarter of 2024.

Supplier purchases

We regularly place purchase orders with our suppliers for inventory and capital expenditures to be used in the ordinary course of business. Open purchase orders as of December 30, 2023 total $83.3 for purchases expected in 2024 and $3.3 for purchases expected in 2025.

Building purchase commitment

The Company is negotiating a lease-to-buy agreement for the purchase of a building with the option to purchase the building at any time during the lease period. Under the draft agreement, the company would commit to purchasing the building at the end of the 6-year lease term. The expected purchase price is €26.7; however, the actual purchase price will be reduced by 60% of the payments made during the lease term.

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Leases

We regularly enter into operating lease agreements for the use of machinery, equipment, vehicles, buildings and office space. Future maturities of our operating lease liabilities are presented in Note 7 of the Notes to the Consolidated Financial Statements included in this Annual Report.

Critical Accounting Policies and Estimates

We prepare our Consolidated Financial Statements in conformity with U.S. GAAP, which requires management to make certain estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. The following policies are considered by management to be the most critical in understanding the judgments, estimates and assumptions that are involved in the preparation of our Consolidated Financial Statements.

Business Combinations

Business combinations are accounted for under the acquisition method of accounting, which requires recognition separately from goodwill, the assets acquired and the liabilities assumed at their acquisition date fair values. Assigning fair market values to the assets acquired and liabilities assumed at the date of an acquisition requires knowledge of current market values, and the values of assets in use, and often requires the application of judgment regarding estimates and assumptions. While the ultimate responsibility resides with management, for certain acquisitions we retain the services of certified valuation specialists to assist with assigning estimated values to certain acquired assets and assumed liabilities, including intangible assets and tangible long-lived assets. Acquired intangible assets, excluding goodwill, are valued using various methodologies such as the discounted cash flow method, which is based on future cash flows specific to the type of intangible asset purchased and the relief from royalty method, which is based on the present value of savings resulting from the right to manufacture or sell products that incorporate the intangible asset without having to pay a license for its use. These methodologies incorporate various estimates and assumptions, the most significant being estimated royalty rates, projected revenue growth rates, profit margins and forecasted cash flows based on the discount rate.

Intangible assets consist primarily of customer relationships, technology, trade names and brands and supply agreements. Amortization is on a straight-line basis over their estimated useful lives and the amortization is reflected in the Consolidated Statements of Operations. The useful lives used are as follows: Customer Relationships - 8 to 26 years; Trade Names and Brands - 10 to 20 years; Technology - 5 to 13 years; and Supply Agreements - 10 years. Intangible assets are tested for impairment if certain circumstances arise that would indicate the carrying amount of the assets may not be recoverable. Such circumstances can include, but are not limited to, a decrease in market price, economic decline, changes in the market, change in business operations or plans for disposition. The assessment of fair value for impairment purposes requires significant judgment by management, which could be negatively impacted by economic decline, market deterioration and changes in other market conditions. Additional information about intangible assets, including the gross and net carrying values for the reported periods and historical and future estimated amortization expense is presented in Note 8 of the Notes to the Consolidated Financial Statements included in this Annual Report. Additional information about our acquisitions, including acquired intangible assets deemed material to the Company’s financial results, is presented in Note 3 of the Notes to the Consolidated Financial Statements included in this Annual Report.

Goodwill

Goodwill represents the excess of the purchase price of an acquisition over the fair value of the net assets acquired. The factors we consider for testing goodwill impairment consist of multiple steps. The first step is identification of our operating segments, followed by the identification of the reporting units, such that the reporting unit has discrete financial information, its operating results are reviewed regularly by management, and its economic characteristics are different form the economic characteristics of the other components of the operating segment.

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The Company performed its assessment of segments for financial reporting and deemed there to be no change from the prior year, as the Company continues to review results and manage the business with a focus on the reporting segment level. As part of the annual test of goodwill impairment the Company considers economic factors and current business operations when assessing the reporting unit structures for the purposes of goodwill impairment testing.

We test goodwill for impairment at the reporting unit level, as of the third quarter period end date, on an annual basis and between annual tests whenever events or circumstances indicate the carrying value of a reporting unit may exceed its fair value. Examples of such circumstances could include, but are not limited to, a significant loss of market share, significant decline in operating results, change in management strategy or operations, economic decline, and other such significant disruptions to the business. The carrying value of assets is calculated at the reporting unit level. An impairment loss is recorded to the extent that the fair value of the goodwill within the reporting unit is less than its carrying value.

In certain circumstances the Company may elect to test goodwill using a qualitative assessment, assessing whether it is more likely than not that the fair value of the reporting unit is less than the carrying value. More often the Company will skip the qualitative step and test goodwill using the following valuation methods. The assessment of fair value for impairment purposes requires significant judgment by management. As quoted market prices are not available for our reporting units, determining whether an impairment occurred requires the valuation of the respective reporting unit, which is estimated using both income-based and market-based valuation methods. We generally use a combination of market and income approach methodologies to estimate the fair value of our reporting units. Management’s assumptions include projected future performance, expected future costs, and expected future economic and market conditions (i.e. inflation, tax rates, end-market or market share deterioration). If these assumptions and estimates are not met or operations are impacted by other factors the reporting units could be subject to goodwill impairment.

The income approach is generally based on a discounted cash flow analysis, which estimates the present value of the projected free cash flows to be generated by the reporting unit. Assumptions used in the analysis include estimated future revenues and expenses, working capital, capital expenditures and other variables. Assumptions made for future cash flows are developed based on consideration of current and future economic conditions, recent sales trends, planned timing of product launches or other relevant variables. Each reporting unit regularly prepares discrete operating forecasts and uses these forecasts as the basis for the assumptions in the discounted cash flow analysis. Within the discounted cash flow models, the Company uses a discount rate, commensurate with its cost of capital but adjusted for inherent business risks, and an appropriate terminal growth factor.

The market approach estimates the value of reporting units by comparing to guideline public companies or guideline transactions. Various valuation multiples of companies that are economically and operationally similar are used as data points for selecting multiples for the reporting units, which are deemed to be market-adjusted multiples based on key data points for guideline public companies. Changes in assumptions or estimates could materially affect the estimated fair value of our reporting units and the potential for impairment. We also reconcile the estimated aggregate fair value of our reporting units resulting from these procedures to our overall market capitalization.

The Company completed its annual goodwill impairment testing for 2023, 2022, and 2021 and determined that the carrying amount of goodwill was not impaired. In 2023, a third party was used to assist in the valuation and testing of three reporting units. The third party provides estimates (such as risk premiums, select multiples, discount rates, etc.) used in conjunction with Management’s estimates and assumptions to calculate the fair value of the reporting unit. These reporting units could be subject to impairment if there is economic decline, expectations for growth are not met, a change to management’s operating outlook, or any significant change to the assumptions, estimates or other risks previously mentioned. Such impairment could negatively impact our operating results.

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Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those 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. To the extent the Company determines that it is more likely than not a deferred income tax asset will not be realized, a valuation allowance is established. The recoverability analysis of the deferred income tax assets and the related valuation allowances requires significant judgment and relies on estimates. At December 30, 2023, valuation allowances against deferred tax assets were $3.0. Refer to Note 12 of the Notes to the Consolidated Financial Statements included in this Annual Report for additional information on the composition of these valuation allowances and information on the $1.3 income tax expense resulting from new valuation allowances established against deferred tax assets.

Our annual tax rate fluctuates based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective government taxing authorities. Significant judgment is required in determining our tax expense and in evaluating our tax positions, including evaluating uncertainties. We review our tax positions quarterly and adjust the balances as new information becomes available. Indefinite reinvestment is determined by management’s judgment about, and intentions concerning, our future operations.

We recognize and measure uncertain tax positions in accordance with ASC 740. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. We adjust these reserves, as well as the related interest and penalties, where appropriate in light of changing facts and circumstances. Settlement of any particular position could require the use of cash. We recognize interest and penalties, if any, related to unrecognized tax benefits in income tax expense.

See Note 12 of the Notes to the Consolidated Financial Statements included in this Annual Report for income tax amounts, including reserves.

Off Balance Sheet Arrangements

We do not engage in any off balance sheet financing arrangements. In particular, we do not have any material interest in variable interest entities, which include special purpose entities and structured finance entities.

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

The operating results of the Hydraulics and Electronics segments included in Management’s Discussion and Analysis of Financial Condition and Results of Operations are presented on a basis consistent with our internal management reporting. Segment information included in Note 16 of the Notes to the Consolidated Financial Statements included in this Annual Report is also presented on this basis. All differences between our internal management reporting basis and accounting principles generally accepted in the U.S. (“U.S. GAAP”), specifically the allocation of certain corporate and acquisition-related costs, are included in Corporate and Other.

Overview

We are a global leader in highly engineered motion control and electronic controls technology for diverse end markets, including construction, material handling, agriculture, energy, recreational vehicles, marine and health and wellness.

We operate under two business segments: Hydraulics and Electronics. The Hydraulics segment designs and manufactures hydraulic cartridge valves, hydraulic quick release couplings as well as engineers complete hydraulic systems. The Electronics segment designs and manufactures customized electronic controls systems and displays for a variety of end markets including industrial, mobile, recreational and health and wellness.

During 2021, we augmented our strategy and accelerated our growth plans by two years with intent to achieve our targeted milestone of over $1 billion in sales with top tier adjusted EBITDA margin of approximately 25% in 2023. We plan to achieve this milestone on a run-rate basis ending the fourth quarter of 2023 through a combination of organic growth, acquisitions made to date as well as execution of our manufacturing and operating strategy.

Acquisitions

Our acquisition activity, driven by our strategic vision, has enabled us to diversify our product offerings and the markets we serve and expand our geographic presence. Prior to 2016, we operated primarily in the hydraulics market with a small presence in electronics.

In January 2021, we acquired the assets of BJN Technologies, LLC, an innovative engineering solutions provider that was founded in 2014. With the acquisition, we formed the Helios Center of Engineering Excellence to centralize our innovation and technology advancements to better leverage existing talents across the electronics segment initially, and then throughout all of Helios.

In July 2021, we completed another flywheel acquisition of NEM S.r.l., an innovative hydraulic solutions company providing customized material handling, construction, industrial vehicle and agricultural applications to its global customer base, predominantly in Europe and Asia. NEM enhances the Helios electro-hydraulic product offering, provides geographic expansion and adds scale to address new markets.

In October 2021, we completed the acquisition of Joyonway, a developer of control panels, software, systems and accessories for the health and wellness industry. Joyonway operates from two locations in China, Shenzhen and Dongguan, both of which are in the hub of electronics and software development in China and give us a foothold for electronics manufacturing in Asia.

In July 2022, we completed the acquisition of the assets of Taimi R&D, Inc., a Canadian manufacturer of innovative hydraulic components that offers ball-less design swivel products, which improve hydraulic reliability of equipment, increase the service life of components and help protect the environment by reduced leakage. Taimi brings a differentiated, yet complementary product line to our hydraulics platform as well as strong engineering breadth.

In September 2022, we completed another flywheel acquisition of Daman Products Company, headquartered in Mishawaka, Indiana. Daman is a leading designer and manufacturer of standard and custom precision hydraulic manifolds and other fluid conveyance products for its customer base, predominantly in North America. The acquisition of Daman expands the Company's technologies and markets and provides an opportunity to produce integrated package offerings with multiple Helios brands.

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In January 2023, we completed the acquisition of Schultes Precision Manufacturing, Inc. Schultes is a highly trusted specialist in manufacturing precision machined components and assemblies for customers requiring very tight tolerances, superior quality, and exceptional value-added manufacturing processes. Currently serving the hydraulic, aerospace, communication, food services, medical device, and dental industries, Schultes brings the manufacturing quality, reliability, and responsiveness critical to its customers’ success. Schultes provides additional manufacturing know-how and expands our business into new end markets with attractive secular tailwinds.

Global Economic Conditions

Russian Invasion of Ukraine

In early 2022, Russia invaded Ukraine. As a result, several governments have enacted sanctions against Russia and Russian interests. The conflict has led to economic uncertainty and market disruptions, including significant volatility in commodity, fuel and energy prices as well as in credit and capital markets. We do not have operations in the region, and less than 1% of our sales are to Russia and Ukraine customers. In Europe, we continue to experience inflation from: increased energy and raw material costs, logistics issues and reduced orders from customers who do business in the region. The broader consequences of the conflict could impact our business through further increases or fluctuations in commodity and energy prices, further disruptions to the global supply chain, reduced availability of certain natural resources and other adverse effects on macroeconomic conditions.

COVID-19 Pandemic

In the first half of 2022, we experienced mild impacts from the pandemic. At the beginning of the second quarter our locations in China began to shut down periodically due to regulatory lockdown measures associated with a COVID-19 outbreak. The shutdown of our locations and our customers' locations impacted operations and sales through May with recovery occurring in June as the lockdowns were lifted. We also faced disruption to our workforce from the pandemic. While the impact was not significant, the absenteeism caused labor inefficiencies in production. Additionally, in certain locations we faced pressure from competitive labor markets. In the second half of 2022, there were no COVID-related shutdowns or other significant new disruption to our business from the pandemic.

Throughout the year, and continuing into 2023, we faced constraints related to sourcing certain electronic and other components, which originated from the high demand for these products caused by the pandemic. We have been able to mitigate some of the impact with our procurement efforts, production schedule adjustments and product redesigns.

Demand in the health and wellness market was favorably impacted by the pandemic in 2020 and 2021, as consumers invested in leisure products and activities. However, during 2022, we experienced a sharp decline in sales in this end market as demand declined and inventory levels in the channel increased.

Refer to Item 1A Risk Factors of this Annual Report for additional COVID-19 related discussion.

Industry Conditions

The capital goods industries in general, and the Hydraulics and Electronics segments specifically, are subject to economic cycles. We utilize industry trend reports from various sources, as well as feedback from customers and distributors, to evaluate economic trends. We also rely on global government statistics such as Gross Domestic Product and Purchasing Managers Index to understand higher level economic conditions.

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Hydraulics

According to the National Fluid Power Association (the fluid power industry’s trade association in the U.S.), the U.S. index of shipments of hydraulic products increased 20% in 2022, after increasing 21% in 2021 and decreasing 20% in 2020. In Europe, the CEMA Business Barometer reports that in December 2022, the business climate index for the European agricultural machinery industry had its first significant upward trend since the sharp declines in the course of the Russian war against Ukraine. CEMA further reported that supply constraints appear to have become more acute in only certain segments while many manufacturers seem increasingly able to realize orders. The CECE (Committee for European Construction Equipment) business climate index bounced back in November after steady decline throughout the year. They reported the favorability was driven by a slightly less tense supply chain.

Electronics

The Federal Reserve’s Industrial Production Index, which measures the real output of all relevant establishments located in the U.S., reports production of semiconductors and other electronics components declined during the fourth quarter of 2022, to the lowest level since the second quarter of 2021. Output peaked in the fourth quarter of 2021. The Institute of Printed Circuits Association (“IPC”) reported that total North American printed circuit board (“PCB”) shipments in December 2022 were down 5.1% compared with November 2022, and for the year orders were down 6.5% while shipments were up 10.1%. The IPC also reported that North American electronics manufacturing services (“EMS”) shipments in December 2022 were up 5.8% compared with November 2022, and for the year orders were down 3.7% while shipments were up 4.5%.

2022 Results and Comparison of Years Ended December 31, 2022 and January 1, 2022

The following table sets forth our consolidated results of operations:

Consolidated net sales for the 2022 year increased $16.2 million, 1.9%, over the prior year. Acquisition growth accounted for a $24.9 million increase while organic sales declined $8.7 million, 1.0%. Discrete impacts to our organic sales compared to 2021 are as follows:

•
Changes in foreign currency exchange rates - unfavorable by $27.6 million, 3.2%

•
Pricing changes - favorable by $40.2 million, 4.6%

•
Delayed sales due to supply chain constraints - unfavorable by an estimated $12.3 million

Our 2022 sales to the Americas and EMEA regions increased compared to 2021, both benefiting from pricing and acquisition-related sales, while sales to the APAC region declined from demand and foreign currency. Demand for electronics products in our health and wellness end market has sharply declined from the prior year, which was strengthened by the pandemic as consumers invested in health and leisure products. Sales growth during the year was realized in the industrial machinery, mobile equipment, construction and recreational end markets.

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Gross profit declined $14.3 million, 4.6%, in 2022 compared to 2021 driven by lower volume, higher material costs and unfavorable foreign currency partially offset by pricing and acquisitions. Changes in foreign currency exchange rates compared to 2021 reduced gross profit by $7.9 million. Gross margin declined 2.3 percentage points over the prior year as pricing efforts did not recover the full margin to offset the impact of higher material costs. Material costs as a percentage of sales, excluding pricing changes and acquisition-related sales, increased in the year-to-date period by 3.3 percentage points compared to the prior year.

During 2022, we incurred $5.2 million of costs related to our restructuring activities. In the EMEA region, we executed an operational restructure in our Hydraulics segment that combined the manufacturing operations at two of our locations into one location. We are continuing our sales and R&D efforts in both locations in order to serve customers in the regions. In the APAC region, we executed an organizational restructure in our Hydraulics segment among several locations to align employee talent with the strategic operational goals of the Company. In our Electronics segment, we executed an organizational restructure to adjust our labor base in line with current demand levels. The restructuring costs are comprised of recurring labor costs for employees who worked on projects of $2.2 million, non-recurring severance and termination benefits of $2.3 million and other expenses of $0.7 million. The restructuring plans are expected to improve the global cost structure of the business.

Operating income as a percentage of sales decreased 1.7 percentage points to 15.5% in 2022 compared with the prior-year period. Operating margin was favorably impacted during 2022 by a $4.7 million decrease in acquisition-related amortization, primarily from the sales order backlog intangible acquired with the Balboa acquisition that was fully amortized in the second quarter of 2021. However, this was offset by the gross margin level changes, non-recurring restructuring costs that were $2.5 million higher in 2022 than the prior period and increased M&A related professional fees totaling $1.9 million.

Net income and EPS benefited from foreign currency transaction gains of $0.9 million in 2022 compared to losses of $1.0 million in 2021, gains on sale of property, plant and equipment primarily related to our restructuring activities totaling $1.8 million and a decrease in tax expense of $3.2 million compared to 2021, primarily due to a decrease in foreign income taxed at different rates and state and local tax benefits.

Segment Results

Hydraulics

The following table sets forth the results of operations for the Hydraulics segment (in millions):

Net sales for the Hydraulics segment grew by $34.9 million, 6.8%, compared with 2021. Acquisition-related sales accounted for $22.4 million of the increase and sales from our organic businesses improved $12.5 million, 2.4%. Discrete impacts to our organic sales compared to the prior year are as follows:

•
Changes in foreign currency exchange rates - unfavorable by $26.2 million, 5.1%

•
Pricing changes - favorable by $23.0 million, 4.5%

•
Delayed sales due to supply chain constraints - unfavorable by an estimated $7.1 million

Organic sales growth in 2022 benefited from improved demand primarily in the Americas and EMEA regions, as well as in several of our end markets including the mobile and industrial equipment markets.

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The following table presents net sales based on the geographic region of the sale for the Hydraulics segment (in millions):

Regional sales performance in 2022 compared to the prior year was driven by:

Americas - demand, pricing and our recent acquisitions contributed to a 19.0% increase in sales

EMEA - excluding unfavorable changes in foreign currency rates of $19.6 million, sales improved 14.5%, primarily from demand, pricing and our 2021 acquisition

APAC - excluding unfavorable changes in foreign currency rates of $6.6 million, sales improved 1.9%, primarily from demand in Japan and India

Costs related to our restructuring activities totaled $4.0 million during 2022; $1.1 million of the costs are included in cost of goods sold and $2.9 million are reflected in selling, engineering and administrative expenses (“SEA”). The restructuring costs are comprised of $2.2 million of recurring labor costs for employees who worked on the restructuring projects, non-recurring severance and termination benefits of $1.1 million and other non-recurring professional fees and expenses associated with the manufacturing relocation of $0.7 million.

During 2022, gross profit improved $2.1 million, 1.1%, over the prior year, favorably impacted by pricing and acquisitions. The segment realized an unfavorable impact on gross profit from changes in foreign currency rates, compared with 2021 of $7.1 million. Gross margin for 2022 decreased 2.0 percentage points as the segment incurred higher material, logistic and energy costs. Freight costs increased $1.9 million in 2022 and material costs as a percentage of sales, excluding pricing changes and acquisition-related sales, increased in 2022 by 2.8 percentage points. Price increases to customers did not fully recover the margin impact of the material cost increases.

SEA expenses decreased $0.8 million, 1.1%, in 2022 compared with the prior year. Changes in foreign currency rates compared to the prior year reduced SEA costs by $3.4 million. Increased SEA expenses from our acquisitions, higher non-recurring restructuring costs of $1.3 million and travel and marketing costs of $1.0 million were partially offset by $1.6 million of savings realized from lower benefit costs, primarily from performance-based incentive compensation accruals. SEA as a percent of sales decreased 1.1 percentage points to 13.2% in 2022 also benefiting from improved leverage of our fixed costs on the higher sales.

Electronics

The following table sets forth the results of operations for the Electronics segment (in millions):

Net sales for the Electronics segment declined by $18.6 million, 5.3%, compared with the prior year. Acquisition-related sales totaled $2.5 million. Discrete impacts to our organic sales compared to the prior year period are as follows:

•
Changes in foreign currency exchange rates - unfavorable by $1.4 million

•
Pricing changes - favorable by $17.2 million, 4.9%

•
Delayed sales due to supply chain constraints - unfavorable by an estimated $5.2 million

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During 2022, demand in our health and wellness end market sharply declined from the prior year, which was strengthened by the pandemic as consumers invested in health and leisure products. Inventory held by customers remained inflated in this end market, which further contributed to the decline. However, we realized sales growth in our recreational and mobile and industrial machinery end markets.

The following table presents net sales based on the geographic region of the sale for the Electronics segment (in millions):

Regional sales performance in 2022 compared to the prior year was driven by:

Americas - demand, pricing and capacity improvements contributed to a 5.1% increase in sales

EMEA - excluding unfavorable changes in foreign currency rates of $1.3 million, sales declined 8.6%, primarily from lower demand in the health and wellness end market

APAC - sales declined 50.7%, from lower demand in the health and wellness end market in China; impacts from foreign currency exchange rates were minimal

In 2022, we executed an organizational restructure to adjust our labor base in line with current demand levels. We incurred $1.2 million of restructuring costs for severance and termination benefits; $0.6 million of the costs are included in cost of goods sold and $0.6 million are reflected in SEA expenses.

The segment experienced a $17.0 million, 14.2%, decrease in gross profit over the prior year, primarily due to lower sales volume and material cost increases. Further, unfavorable impacts from changes in foreign currency exchange rates compared to the prior year totaled $0.9 million. Gross margin for 2022 decreased 3.2 percentage points from the higher material costs as the margin was not fully recovered by pricing efforts. Material costs as a percentage of sales, excluding pricing changes and acquisition-related sales, increased in 2022 by 4.7 percentage points compared to 2021.

SEA expenses increased $2.2 million, 4.6%, in 2022 compared with the prior year primarily from our 2021 acquisition, higher costs for salaries of $1.5 million and travel and marketing of $0.7 million offset by lower benefit costs of $1.1 million, mainly from performance-based incentive compensation accruals, and lower R&D costs of $0.5 million. SEA as a percent of sales increased 1.4 percentage points to 15.1% in 2022 from 13.7% in 2021, further impacted by reduced leverage of our fixed costs on the lower sales.

Corporate and Other

Certain costs are excluded from business segment results as they are not used in evaluating the results of, or allocating resources to, our operating segments. For the year ended December 31, 2022, these costs totaled $37.9 million for (i) transition costs for one of our executive officers of $0.3 million, (ii) amortization of acquisition-related intangible assets of $28.1 million and (iii) $9.5 million related to other acquisition and integration activities.

For the year ended January 1, 2022, these costs totaled $42.2 million primarily for acquisition-related items such as (i) transaction costs of $4.0 million, (ii) charges related to inventory step-up to fair value of $0.6 million, (iii) amortization of acquisition-related intangible assets of $32.8 million, (iv) $4.6 million related to other acquisition and integration activities and (v) other costs not deemed allocable to either business segment of $0.2 million.

Interest Expense, net

Net interest expense decreased $0.2 million during 2022 to $16.7 million compared with $16.9 million in 2021. The change is attributable to lower average debt levels during 2022, as repayments exceeded borrowings used to fund acquisitions, offset by higher interest rates when compared to 2021. Average net debt decreased by $17.4 million during 2022 to $409.5 million compared with $426.9 million in 2021.

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Income Taxes

The provision for income taxes for the year ended December 31, 2022, was 19.2% of pretax income compared with 20.3% for the year ended January 1, 2022. The difference relates principally to a shift in the mix of the company's worldwide income and favorable provision to return state tax adjustments related to the 2021 filed tax returns. The effective rate typically fluctuates relative to the levels of income and different tax rates in effect from year to year among the countries in which we sell our products.

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was enacted into law in response to the COVID-19 pandemic. The Company has evaluated the various income and payroll tax provisions and expects little or no impact to income tax expense. However, the Company is taking advantage of the various payment deferments allowed and employee retention credits afforded by the CARES Act and other similar state and/or foreign liquidity measures. The CARES Act allows employers to defer the deposit and payment of the employer's share of Social Security taxes. We deferred 50% of the $1.7 million in payroll taxes normally due between March 27, 2020 and December 31, 2020. We paid 50% of this amount during the fourth quarter of 2021 and the remaining balance was paid during the fourth quarter of 2022.

On August 16, 2022, the Inflation Reduction Act was enacted into law, and includes, among other things, a new 15% minimum tax and 1% excise tax on stock repurchases after December 31, 2022. While these tax law changes have no immediate effect and are not expected to have a material impact on our future financial results, we will continue to evaluate its impact as further information becomes available.

As of December 31, 2022, the Company had approximately $25.2 million of undistributed earnings of its non-U.S. subsidiaries for which it has not provided for non-U.S. withholding taxes and state taxes because such earnings are intended to be reinvested indefinitely in international operations.

2021 Results and Comparison of Years Ended January 1, 2022 and January 2, 2021

For the discussion and analysis of our 2021 results compared with our 2020 results, refer to our Annual Report on Form 10-K for the fiscal year ended January 1, 2022, filed with the SEC on March 1, 2022. The discussion is incorporated herein by reference.

Liquidity and Capital Resources

Historically, our primary source of capital has been cash generated from operations. We also use borrowings on our credit facilities to fund acquisitions. During 2022, net cash provided by operating activities totaled $109.9 million and as of December 31, 2022 we had $43.7 million of cash on hand and $138.8 million of available credit on our revolving credit facilities. We also have a $300.0 million accordion feature available on our credit facility, which is subject to certain pro forma compliance requirements and is intended to support potential future acquisitions.

Our principal uses of cash have been paying operating expenses, making capital expenditures, servicing debt, making acquisition-related payments and paying dividends to shareholders.

We believe that cash generated from operations and our borrowing availability under our credit facilities will be sufficient to satisfy our operating expenses and capital expenditures for the foreseeable future. In the event that economic conditions were to severely worsen for a protracted period of time, we would have several options available to ensure liquidity in addition to increased borrowing. Capital expenditures could be postponed since they primarily pertain to long-term improvements in operations, operating expense reductions could be made and the dividend to shareholders could be reduced or suspended.

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Cash flows

The following table summarizes our cash flows for the periods (in millions):

Cash on hand increased $15.2 million to $43.7 million at the end of 2022. Cash and cash equivalents were favorably impacted by changes in exchange rates by $3.0 million during the years ended December 31, 2022 and January 1, 2022. Cash balances on hand are a result of our cash management strategy, which focuses on maintaining sufficient cash to fund operations while reinvesting cash in the Company and also paying down borrowings on our credit facilities.

Operating activities

Net cash from operations totaled $109.9 million in 2022, a decrease of $3.2 million, 2.8%, compared with the prior year. Cash earnings (calculated as net income plus adjustments to reconcile net income to net cash provided by operating activities, excluding changes in net operating assets and liabilities) decreased by $12.4 million compared to the prior year. However, changes in net operating assets and liabilities increased cash by $9.2 million compared to 2021, primarily from favorable cash flows from AR and inventories only partially offset by reductions in AP and accrued expenses. Investments in inventory, net of acquisitions, reduced cash by $27.0 million and $52.5 million in 2022 and 2021, respectively. Inventory on hand as of December 31, 2022 increased by $26.0 million, 15.7%, compared to the 2021 year end. The increase is primarily from higher material costs and supply chain challenges such as (i) making earlier purchases of material to avoid shortages, (ii) inventory on hand that is waiting on delayed components to complete and (iii) delayed orders by customers after we have already started the production process. Days of inventory on hand increased to 111 days for the 2022 year, compared with 91 days during the 2021 year. Changes in accounts receivable, net of acquisitions, increased cash by $9.1 million in 2022 compared with a decrease in cash of $32.4 million in 2021, a result of lower sales in the last few months of the 2022 year compared to 2021. Days sales outstanding for the 2022 year decreased slightly to 52 days, from 57 days during 2021, impacted by the lower fourth quarter sales compared to the first three quarters of 2022 as our collection patterns remain consistent with the prior year.

Investing activities

Cash used in investing activities totaled $90.8 million in 2022, which was largely in line with the prior period of $90.3 million. The increase in acquisition-related payments accounted for $3.8 million of the fluctuation. Capital expenditures were $31.9 million during 2022, $5.1 million, 19.0%, higher than the prior year primarily from investments in machinery and equipment. These increases in cash used were partially offset by proceeds from dispositions of property, plant and equipment which was $7.0 million higher than 2021, driven by the sale of a building related to our restructuring projects. Capital expenditures for 2023 are forecasted to be approximately 3%-5% of sales, for investments in machinery and equipment for capacity expansion projects, improvements to manufacturing technology and maintaining/replacing existing machine capabilities.

Financing activities

Net cash used in financing activities totaled $6.9 million in 2022, compared with $22.6 million in 2021.

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Borrowings, net of repayments, on our credit facilities in 2022 totaled $8.0 million as borrowings of approximately $65.0 million for the Daman acquisition were not offset fully by repayments during the year. In the 2021 year, repayments, net of borrowings, on our credit facilities totaled $9.8 million as acquisition related borrowings of $56.7 million were more than offset by repayments during the year.

Borrowings on our term loans and revolving credit facilities as of December 31, 2022 totaled $183.6 million and $262.9 million, respectively. See Note 10 of the Notes to the Consolidated Financial Statements included in this Annual Report for additional information regarding our credit facilities.

We have historically declared regular quarterly dividends to shareholders of $0.09 per share. We paid dividends totaling $11.7 million and $11.6 million for the years ended December 31, 2022 and January 1, 2022, respectively. The declaration and payment of future dividends is subject to the sole discretion of the board of directors, and any determination as to the payment of future dividends will depend upon our profitability, financial condition, capital needs, acquisition opportunities, future prospects and other factors deemed pertinent by the board of directors.

Contractual obligations

Credit facilities

Information on our credit facilities, including future maturities, is presented in Note 10 of the Notes to the Consolidated Financial Statements included in this Annual Report. Our revolving credit facility with PNC Bank matures and is payable in full in October 2025; however, we may make earlier payments. Our term loan with PNC Bank is payable in quarterly installments of $3.8 million through 2023 and quarterly installments of $5.0 million thereafter through the maturity date of October 2025, at which time the remaining balance will be due in full.

Interest rates on our credit facilities range from 3.9% to 6.4% as of December 31, 2022. Future interest payments are estimated to total $71.6 million, with annual payments ranging from $26.3 million to $20.8 million payable through the last maturity date of October 2025. Future payments assume the current interest rate environment, current currency exchange rates, future required payments on term loans and revolver borrowings consistent with December 31, 2022 debt levels. Future payments do not include an estimate of impacts from our derivative instruments.

Contingent consideration payments

Our contingent consideration liabilities total $6.7 million as of December 31, 2022. The balance represents the fair value estimate of contractual contingent payments related to our acquisitions of Balboa and NEM and are payable at various times through the last quarter of 2024.

Supplier purchases

We regularly place purchase orders with our suppliers for inventory and capital expenditures to be used in the ordinary course of business. Open purchase orders as of December 31, 2022 total $131.2 million for purchases expected in 2023 and $15.2 million for purchases expected in 2024.

Building purchase commitment

In 2020, the Company entered into a lease to buy agreement for the purchase of a building. We have the option to purchase the building at any time during the lease period and are committed to buy at the end of the 6-year lease term. The full purchase price is €26.7 million; however, the actual purchase price will be reduced by 60% of the payments made during the lease term.

Leases

We regularly enter into operating lease agreements for the use of machinery, equipment, vehicles, buildings and office space. Future maturities of our operating lease liabilities are presented in Note 7 of the Notes to the Consolidated Financial Statements included in this Annual Report.

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Critical Accounting Policies and Estimates

We prepare our Consolidated Financial Statements in conformity with U.S. GAAP, which requires management to make certain estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. Based on facts and circumstances inherent in developing estimates and assumptions, we believe it is unlikely that applying other such estimates and assumptions would have caused materially different amounts to have been reported. The following policies are considered by management to be the most critical in understanding the judgements, estimates and assumptions that are involved in the preparation of our Consolidated Financial Statements.

Business Combinations

Business combinations are accounted for under the acquisition method of accounting, which requires recognition separately from goodwill, the assets acquired and the liabilities assumed at their acquisition date fair values. Assigning fair market values to the assets acquired and liabilities assumed at the date of an acquisition requires knowledge of current market values, and the values of assets in use, and often requires the application of judgment regarding estimates and assumptions. While the ultimate responsibility resides with management, for certain acquisitions we retain the services of certified valuation specialists to assist with assigning estimated values to certain acquired assets and assumed liabilities, including intangible assets and tangible long-lived assets. Acquired intangible assets, excluding goodwill, are valued using various methodologies such as the discounted cash flow method, which is based on future cash flows specific to the type of intangible asset purchased and the relief from royalty method, which is based on the present value of savings resulting from the right to manufacture or sell products that incorporate the intangible asset without having to pay a license for its use. These methodologies incorporate various estimates and assumptions, the most significant being estimated royalty rates, projected revenue growth rates, profit margins and forecasted cash flows based on the discount rate.

Goodwill

Goodwill represents the excess of the purchase price of an acquisition over the fair value of the net assets acquired. Goodwill is tested for impairment annually or more frequently if events or circumstances indicate a reduction in the fair value below the carrying value. The carrying value of assets is calculated at the reporting unit level. An impairment loss is recorded to the extent that the fair value of the goodwill within the reporting unit is less than its carrying value.

The assessment of fair value for impairment purposes requires significant judgment by management. We generally use a combination of market and income approach methodologies to estimate the fair value of our reporting units. The income approach is generally based on a discounted cash flow analysis, which estimates the present value of the projected free cash flows to be generated by the reporting unit. Assumptions used in the analysis include estimated future revenues and expenses, weighted average cost of capital, capital expenditures and other variables. Assumptions made for future cash flows are developed based on consideration of current and future economic conditions, recent sales trends, planned timing of product launches or other relevant variables. The market approach estimates the value of reporting units by comparing to guideline public companies or guideline transactions. Various valuation multiples of companies that are economically and operationally similar are used as data points for selecting multiples for the reporting units. Changes in assumptions or estimates could materially affect the estimated fair value of our reporting units and the potential for impairment.

Income Taxes

Our income tax policy provides for a balance sheet approach under which deferred income taxes are provided for based upon enacted tax laws and rates applicable to the periods in which the taxes become payable. These differences result from items reported differently for financial reporting and income tax purposes, primarily depreciation, amortization, accrued expenses and reserves.

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Our annual tax rate fluctuates based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective government taxing authorities. Significant judgment is required in determining our tax expense and in evaluating our tax positions, including evaluating uncertainties. We review our tax positions quarterly and adjust the balances as new information becomes available. Indefinite reinvestment is determined by management’s judgment about, and intentions concerning, our future operations.

We recognize and measure uncertain tax positions in accordance with ASC 740. We report a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. We file annual income tax returns in multiple taxing jurisdictions around the world. Many years may pass before an uncertain tax position is audited by the relevant tax authorities and finally resolved. While it is often difficult to predict the outcome or the timing of resolution of any particular uncertain tax position, we believe that our reserves for income taxes are adequate such that we reflect the benefits more likely than not to be sustained in an examination. We adjust these reserves, as well as the related interest and penalties, where appropriate in light of changing facts and circumstances. Settlement of any particular position could require the use of cash. We recognize interest and penalties, if any, related to unrecognized tax benefits in income tax expense.

See Note 12 of the Notes to the Consolidated Financial Statements included in this Annual Report for income tax amounts, including reserves.

Off Balance Sheet Arrangements

We do not engage in any off balance sheet financing arrangements. In particular, we do not have any material interest in variable interest entities, which include special purpose entities and structured finance entities.

Inflation

As more fully described above, we are experiencing supply shortages and increasing material and logistics costs. Continued increases in the global demand for the materials used in our products could result in significant increases in the costs of the components we purchase, and we may not be able to fully offset such higher costs through price increases. There is no assurance that our business will not be materially affected by inflation in the future.

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

The operating results of the Hydraulics and Electronics segments included in Management’s Discussion and Analysis of Financial Condition and Results of Operations are presented on a basis consistent with our internal management reporting. Segment information included in Note 16 of the Notes to the Consolidated Financial Statements included in this Annual Report is also presented on this basis. All differences between our internal management reporting basis and accounting principles generally accepted in the U.S. (“U.S. GAAP”), specifically the allocation of certain corporate and acquisition-related costs, are included in Corporate and Other.

Overview

We are a global leader in highly engineered motion control and electronic controls technology for diverse end markets, including construction, material handling, agriculture, energy, recreational vehicles, marine and health and wellness.

We operate under two business segments: Hydraulics and Electronics. The Hydraulics segment designs and manufactures hydraulic cartridge valves, hydraulic quick release couplings as well as engineers complete hydraulic systems. The Electronics segment designs and manufactures customized electronic controls systems and displays for a variety of end markets including industrial and mobile, recreational and health and wellness.

In November 2016, we set out a vision to achieve $1 billion in sales in 2025 through a combination of organic growth and acquisitions and to deliver operating margins in excess of 20%. In 2021, we augmented our strategy and accelerated our growth plans to achieve the milestone of over $1 billion in sales with top tier adjusted EBITDA margin of approximately 25% in 2023.

Underpinning our expectation of compounded annual growth of approximately two times our market's growth rates, we have an active pipeline and a history of acquiring companies with niche technologies, as well as strong profitability.

Acquisitions

Our acquisition activity, driven by our strategic vision, has enabled us to diversify our product offerings and the markets we serve and expand our geographic presence. Prior to 2016, we operated primarily in the Hydraulics market with a small presence in electronics.

In November 2020, we acquired Balboa Water Group, further diversifying the markets we serve and expanding our technological capabilities in electronics. Balboa is an innovative market leader of electronic controls for the health and wellness industry with proprietary and patented technology that enables end-to-end electronic control systems for therapy baths and traditional and swim spas.

In January 2021, we acquired the assets of BJN Technologies, LLC, an innovative engineering solutions provider that was founded in 2014. With the acquisition, we formed the Helios Center of Engineering Excellence to centralize our innovation and technology advancements to better leverage existing talents across the electronics segment initially, and then throughout all of Helios.

In July 2021, we completed another flywheel acquisition with NEM S.r.l., an innovative hydraulic solutions company providing customized material handling, construction, industrial vehicle and agricultural applications to its global customer base, predominantly in Europe and Asia. NEM enhances the Helios electro-hydraulic product offering, provides geographic expansion and adds scale to address new markets.

In October 2021, we completed the acquisition of Joyonway. Joyonway is a fast-growing developer of control panels, software, systems and accessories for the health and wellness industry. Joyonway operates from two locations in China, Shenzhen and Dongguan, both of which are in the hub of electronics and software development in China and give us a foothold for electronics manufacturing in Asia.

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Global Economic Conditions

COVID-19 Update

The COVID-19 pandemic has caused, and continues to cause, economic disruption globally, and substantial uncertainty exists regarding the magnitude and duration of the pandemic and its economic impact.

Many of our customers and end markets are recovering from the substantial impacts of the pandemic experienced during 2020. Demand in 2021 for our products exceeded our expectations as end market recovery occurred sooner and was stronger than we projected. Demand in the health and wellness and recreational marine markets has been favorably impacted by the pandemic as consumers are investing in leisure products and activities. We face constraints on our ability to source certain electronic and other components, which originated from the high demand for these products caused by the pandemic. While we have been able to mitigate the majority of the impact with our procurement efforts and production schedule adjustments, we are experiencing delays in shipments as well as material and logistics cost increases.

We are also facing disruption to our workforce from the pandemic. While the impact has not been significant, the absenteeism has caused labor inefficiencies in production. The Omicron variant impacted fourth quarter labor efficiency, and we continued to experience the effects through January 2022. Additionally, in certain locations we are facing pressure from competitive labor markets; however, to date we have been successful at minimizing the impact on our operations using various methods including reallocating resources, attending job fairs and increasing wages when appropriate. We are closely monitoring the various laws, regulations and executive orders that could impact future periods relating to government-imposed requirements regarding mandatory testing for COVID-19 in the workplace and/or vaccination requirements for employees. The Company has taken and is in the process of taking necessary steps to comply with applicable requirements. At this time, we do not believe there will be a material impact on our operations due to these requirements.

Our outlook for the 2022 fiscal year assumes the global economy continues to recover; however, we cannot at this time predict any future impacts. The Company continues to monitor developments, new strains and variants of COVID-19 and government requirements and recommendations at the national, state and local levels, as well as vaccine mandates, to evaluate whether to reinstate and/or extend certain initiatives it implemented to help contain the spread of COVID-19. Refer to Item 1A Risk Factors of this Annual Report for additional COVID-19 related discussion.

Industry Conditions

Market demand for our products is dependent on demand for the industrial goods in which the products are incorporated. The capital goods industries in general, and the Hydraulics and Electronics segments specifically, are subject to economic cycles. We utilize industry trend reports from various sources, as well as feedback from customers and distributors, to evaluate economic trends. We also rely on global government statistics such as Gross Domestic Product and Purchasing Managers Index to understand higher level economic conditions.

Hydraulics

According to the National Fluid Power Association (the fluid power industry’s trade association in the U.S.), the U.S. index of shipments of hydraulic products increased 21% in 2021, after decreasing 20% in 2020 and decreasing 7% in 2019. In Europe, the CEMA Business Barometer reports that in January 2022, the business climate index for the European agricultural machinery industry stabilized at a high level after several months of slight downward correction since its peak in May and June. CEMA further reported that the near future turnover is already secured, and there is still growth potential for the time being, which might initially be delayed into the coming months due to the supply bottlenecks. The CECE (Committee for European Construction Equipment) business climate index went down slightly in November. They reported, however, that order intake and sales in Europe continue to be on a growth path as future sales expectations have stabilized or even slightly improved for virtually all market regions.

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Electronics

The Federal Reserve’s Industrial Production Index, which measures the real output of all relevant establishments located in the U.S., reports production of semiconductors and other electronics components continued to improve during the fourth quarter of 2021, exceeding fourth quarter 2020 levels. The Institute of Printed Circuits Association ("IPC") reported that total North American printed circuit board ("PCB") shipments in December 2021 were up 16.9% compared with the same month last year, and compared with November 2021, December shipments grew 21.5%. The IPC also reported that North American electronics manufacturing services ("EMS") shipments were up 0.9% compared to the same month last year, and compared to November 2021, shipments rose 8.0%. Demand continues to exceed supply for both PCB and EMS products as the book-to-bill ratios were at 1.17 and 1.55, respectively, in December 2021, as reported by the IPC.

2021 Results and Comparison of Years Ended January 1, 2022 and January 2, 2021

The following table sets forth our consolidated results of operations:

Consolidated net sales for the 2021 year totaled $869.2 million, an increase of 66.2% over the prior year. Acquisitive growth accounted for a large portion of the increase, $206.6 million, and we also experienced significant organic growth of $139.6 million, 26.7%. Changes in foreign currency exchange rates favorably impacted sales by $12.4 million, and earnings per share by $0.05 compared to 2020. The effect of price increases impacted 2021 organic sales by $4.4 million compared to 2020. We realized improved demand in all regions in both segments as our end markets recovered from the significant impacts of the COVID-19 pandemic. In early 2020, we experienced a considerable negative impact on sales due to facility closures, customer shut-downs and regulatory restrictions imposed on shipments. Our production capabilities recovered throughout the year and towards the end of the 2020, we began to experience end market recovery. Strong recovery continued throughout the 2021 year driven by demand in the European agricultural and U.S. recreational marine markets as well as the construction equipment and health and wellness industries. From a geographic perspective, our 2021 organic sales to the Americas, EMEA and APAC regions grew 31.1%, 30.3% and 17.1%, respectively.

Gross profit trended upward in 2021 compared to 2020 due to the increased sales volume. Gross profit margin declined 1.5 percentage points during 2021 to 36.0% from 37.5% as improved manufacturing labor efficiencies and leverage of our fixed cost base on the higher sales were more than offset by increases in logistic and raw material costs and the addition of sales from Balboa, which have a different margin profile compared to our legacy businesses (higher material and production costs with lower selling, engineering and administrative ("SEA") costs). Material costs as a percentage of sales, excluding pricing changes and acquisition-related sales, increased in 2021 by 3.0 percentage points compared to 2020 driven by raw material cost increases, primarily from supply shortages, higher freight and logistics costs and an unfavorable change in sales mix. We have passed on material and freight cost increases to customers by implementing price increases, which we expect to continue to realize the effects of in future quarters. The impact of amortization of acquisition-related inventory step up costs resulting from our acquisitions declined by $1.3 million in 2021 compared to 2020.

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Operating income as a percentage of sales increased 10.4 percentage points to 17.2% in 2021 compared to 6.8% in 2020. During the first quarter of 2020, current and expected economic impacts from the COVID-19 pandemic led to an impairment charge of $31.9 million. Excluding the impairment charge in 2020, operating income as a percentage of sales in 2021 improved 4.3 percentage points, up from 12.9%, resulting from improved leverage of our fixed cost base on the higher sales volume, the favorable operating margin profile of Balboa and a decrease in costs related to CEO and officer transitions of $2.4 million. Operating margin was unfavorably impacted during 2021 by a $10.7 million increase in intangible amortization from our recent acquisitions and higher corporate compensation and benefit costs of $6.3 million, which were primarily related to performance-based incentive compensation earned from the strong financial performance of the company in 2021.

Segment Results

Hydraulics

The following table sets forth the results of operations for the Hydraulics segment (in millions):

Net sales for the Hydraulics segment totaled $516.4 million in 2021, an increase of $109.2 million, 26.8%, over the prior year. Acquisition-related sales accounted for $10.4 million of the increase and sales from our organic businesses improved $98.8 million, 24.3%. Changes in foreign currency exchange rates favorably impacted sales for the year by $12.0 million compared to the 2020 year. The effect of price increases impacted 2021 organic sales by $0.8 million compared to 2020. Strong end market recovery from the pandemic led to improved demand in all regions and many of our end markets including U.S. and European agriculture and construction equipment markets as well as mobile and industrial equipment markets. The segment’s supply chain is experiencing constraints on its ability to source certain components. While the effect on sales has been mitigated by our increased procurement efforts and production schedule adjustments, we estimate that approximately $6.4 million of sales were delayed into future quarters due to the supply shortages.

The following table presents net sales based on the geographic region of the sale for the Hydraulics segment (in millions):

Demand in the Americas region drove sales growth of $37.2 million, 28.5%, compared with the prior year. Increased demand, primarily in the agriculture and construction equipment end markets, and our recent acquisition in the region generated an additional $48.8 million, 37.2%, of sales to the EMEA region compared with 2020, or 32.1% excluding positive impacts from foreign currency exchange rate fluctuations totaling $6.7 million. Sales to the APAC region were up $23.2 million, 15.9%, in 2021 over 2020, or 12.3% excluding positive impacts from foreign currency exchange rate fluctuations totaling $5.3 million. The APAC growth primarily resulted from increased demand in Korea and China.

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Gross profit in 2021 trended up from 2020, due to higher sales volume and a favorable impact from changes in foreign currency exchange rates of $3.7 million. Gross profit margin improved by 0.6 percentage points from improved leverage of our fixed manufacturing costs on the higher sales and labor efficiencies realized as our workforce was more normalized compared to the effects of the pandemic in 2020. Raw material costs increased in 2021, and supplier constraints led to higher material costs from second vendor sourcing efforts. Excess freight and logistics costs totaled $3.8 million in 2021. Material costs as a percentage of sales, excluding pricing changes and acquisition-related sales, increased by 1.9 percentage points in 2021, also impacted by an unfavorable change in sales mix.

SEA expenses increased $5.3 million, 7.8%, in 2021 compared with the prior year. During 2020, we instituted strict cost control measures in light of the COVID-19 pandemic and its expected impacts on the world economies and our operations. While costs related to travel and marketing continue to be low, other SEA costs returned to a more normal level in 2021. Salary and benefit costs have increased driven by wage increases and higher performance-based incentive compensation. Increased leverage of our fixed cost base on higher sales led to SEA as a percentage of sales decreasing 2.5 percentage points to 14.3% in 2021.

As a result of the impacts to gross profit and SEA costs noted above, 2021 operating income improved $37.8 million, 46.1%, compared with 2020, and 2021 operating margin improved 3.1 percentage points during the year.

Electronics

The following table sets forth the results of operations for the Electronics segment (in millions):

Net sales for the Electronics segment totaled $352.7 million in 2021, an increase of $236.9 million, 204.6%, over the prior year. Acquisition growth accounted for $196.2 million of current-year sales. The segment also realized solid organic growth of $40.7 million, 35.1% compared with 2020. The effect of price increases impacted 2021 organic sales by $3.6 million compared to 2020. Changes in foreign currency exchange rates favorably impacted 2021 sales by $0.4 million compared to 2020. During the 2020 year, we experienced significant demand reductions caused by the COVID-19 pandemic as many of our customers shut down operations for a period of time and several of our large OEM customers adjusted the timing of order request dates into later quarters.

Demand in the health and wellness and spa and bath industries has been boosted by the pandemic as consumers invest in health and leisure products. The same trend is occurring in the recreational vehicle and recreational marine industries in which demand continues to remain strong. We have taken swift and successful actions to expand production capacity in an effort to fulfill the high incoming order levels for our products. The segments’ supply chain is experiencing constraints on its ability to source certain electronic and other components. While the effect on sales has been mitigated by our increased procurement efforts and production schedule adjustments, we estimate that approximately $14.8 million of sales were delayed into future quarters due to the supply shortages.

The following table presents net sales based on the geographic region of the sale for the Electronics segment (in millions):

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During 2021, we experienced significant growth in all regions, which was primarily attributable to the acquisitions of Balboa Water Group and Joyonway as well as robust organic growth. Sales to the Americas region during 2021 accounted for 73.1% of total segment sales, a decrease from 81.1% in 2021, which is due to a variation in the regional footprint of our acquisitions. Similarly, sales to EMEA and APAC increased to 11.9% and 15.0% of total segment sales in 2021, respectively.

Gross profit increased $72.2 million compared with 2020 due to the increased sales volume. Gross profit margin for the same period decreased by 7.3 percentage points. Balboa product sales have a different margin profile than our historical business (higher material and production costs with lower SEA costs). The addition of Balboa sales in 2021 reduced profitability at the gross margin level while improving profitability at the operating margin level due to their lower operating cost structure. Additionally, the segment experienced an increase in raw material and freight and logistics costs during the year due to the high demand and shortages of materials in the market for electronic and other components used in our products. Excess freight and logistics costs on organic sales totaled $4.0 million in 2021. Material costs as a percentage of sales, excluding pricing changes and acquisition-related sales, increased in 2021 by 6.6 percentage points compared to the prior year.

SEA expenses increased by $19.9 million in 2021, compared with 2020, primarily from the Balboa acquisition. SEA costs as a percentage of sales declined 10.8 percentage points to 13.7% in 2021, compared to 24.5% in 2020. The improvement is due to the favorable cost structure of Balboa as well as increased leverage on our fixed cost base on higher sales in our legacy Electronics business. We also realized increases in personnel costs for wages and benefits primarily from higher payout of performance-based incentive compensation.

As a result of the impacts to gross profit and SEA costs noted above, operating income improved $52.3 million, over the 2020 year and operating margin improved 3.5 percentage points, to 20.3%.

Corporate and Other

Certain costs are excluded from business segment results as they are not used in evaluating the results of, or allocating resources to, our operating segments. For the year ended January 1, 2022, these costs totaled $42.2 million primarily for acquisition-related items such as (i) transaction costs of $4.0 million, (ii) charges related to inventory step-up to fair value of $0.6 million, (iii) amortization of acquisition-related intangible assets of $32.8 million, (iv) $4.6 million related to other acquisition and integration activities and (v) other costs not deemed allocable to either business segment of $0.2 million.

For the year ended January 2, 2021, these costs totaled $65.9 million for (i) goodwill impairment of $31.9 million, (ii) transition costs for two of our officers, including our former Chief Executive Officer totaling $2.6 million, (iii) acquisition-related items such as transaction costs of $6.6 million, (iv) charges related to inventory step-up to fair value of $1.9 million, (v) amortization of acquisition-related intangible assets of $22.1 million and (vi) $0.9 million related to other acquisition and integration activities.

Interest Expense, net

Net interest expense increased $3.6 million during 2021 to $16.9 million compared with $13.3 million in 2020. The increase is attributable to higher average debt levels during 2021 due to our borrowings used to fund the acquisitions of Balboa in November 2020 and NEM and Joyonway in 2021. Average net debt during 2021 totaled $426.9 million compared with $357.8 million in 2020.

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Income Taxes

The provision for income taxes for the year ended January 1, 2022, was 20.3% of pretax income compared with 17.6%, before non-deductible impairment related charges, for the year ended January 2, 2021. The difference relates principally to a shift in the mix of the company's worldwide income. The effective rate typically fluctuates relative to the levels of income and different tax rates in effect from year to year among the countries in which we sell our products. The Company benefited from statutory audit adjustments and certain COVID-19 related tax legislation, which favorably impacted the 2020 tax rate.

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was enacted into law in response to the COVID-19 pandemic. The Company has evaluated the various income and payroll tax provisions and expects little or no impact to income tax expense. However, the Company is taking advantage of the various payment deferments allowed and employee retention credits afforded by the CARES Act and other similar state and/or foreign liquidity measures. The CARES Act allows employers to defer the deposit and payment of the employer's share of Social Security taxes. We deferred 50% of the $1.7 million in payroll taxes normally due between March 27, 2020 and December 31, 2020. We paid 50% of this amount during the fourth quarter of 2021. The remaining balance will be paid during the fourth quarter of 2022 and is included in the Accrued compensation and benefits line item in the accompanying Consolidated Balance Sheets.

As of January 1, 2022, the Company had approximately $23.7 million of undistributed earnings of its non-U.S. subsidiaries for which it has not provided for non-U.S. withholding taxes and state taxes because such earnings are intended to be reinvested indefinitely in international operations.

2020 Results and Comparison of Years Ended January 2, 2021 and December 28, 2019

For the discussion and analysis of our 2020 results compared with our 2019 results, refer to our Annual Report on Form 10-K for the fiscal year ended January 2, 2021, filed with the SEC on March 2, 2021. The discussion is incorporated herein by reference.

Liquidity and Capital Resources

Historically, our primary source of capital has been cash generated from operations. In recent years we have used borrowings on our credit facilities to fund acquisitions. During 2021, net cash provided by operating activities totaled $113.2 million and as of January 1, 2022 we had $28.6 million of cash on hand and $158.0 million of available credit on our revolving credit facilities. We also have a $300.0 million accordion feature available on our credit facility, which is subject to certain pro forma compliance requirements and is intended to support potential future acquisitions.

Our principal uses of cash have been paying operating expenses, making capital expenditures, servicing debt, making acquisition-related payments and paying dividends to shareholders.

We believe that cash generated from operations and our borrowing availability under our credit facilities will be sufficient to satisfy our operating expenses and capital expenditures for the foreseeable future. In the event that economic conditions were to severely worsen for a protracted period of time, we would have several options available to ensure liquidity in addition to increased borrowing. Capital expenditures could be postponed since they primarily pertain to long-term improvements in operations, operating expense reductions could be made and the dividend to shareholders could be reduced or suspended.

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Cash flows

The following table summarizes our cash flows for the periods (in millions):

Cash on hand increased $3.3 million from $25.3 million at the end of 2020 to $28.6 million at the end of 2021. Cash and cash equivalents were favorably impacted by changes in exchange rates during the year ended January 1, 2022 by $3.0 million and unfavorably impacted during the year ended January 2, 2021 by $7.3 million. Cash balances on hand are a result of our cash management strategy, which focuses on maintaining sufficient cash to fund operations while reinvesting cash in the Company and also paying down borrowings on our credit facilities.

Operating activities

Net cash from operations totaled $113.2 million in 2021, an increase of $4.6 million, 4.2%, compared with the prior year. Cash earnings in 2021 were higher by $65.5 million compared to 2020 from the increased sales. However, changes in net operating assets and liabilities reduced cash by $60.9 million compared to 2020, as higher working capital levels were necessary to support our significant increase in operations. Changes in inventory, net of acquisitions, reduced cash by $52.5 million in 2021 compared with an increase in cash of $0.6 million during 2020. Inventory on hand as of January 1, 2022 increased by $55.3 million, 50.1%, compared to the 2020 year end. The increase is primarily from supply chain constraints as well as higher demand expectations for the next few quarters. Some of the supply challenges that have resulted in higher inventory levels are: (i) making earlier purchases of material to avoid shortages, (ii) inventory on hand that is waiting on delayed components to complete and (iii) delayed orders by customers after we have already started the production process. Days of inventory on hand decreased to 91 days for the 2021 year, compared with 100 days during the 2020 year, favorably impacted by the addition of Balboas operations. Changes in accounts receivable, net of acquisitions, decreased cash by $32.4 million in 2021 compared with an increase in cash of $0.7 million in 2020, a direct result of higher sales in the last few months of the 2021 year compared to 2020. Days sales outstanding for the 2021 year went up slightly to 57 days, from 50 days during 2020.

Investing activities

Cash used in investing activities totaled $90.3 million in 2021, compared with $235.9 million in 2020. The decrease in acquisition-related payments accounted for $153.5 million of the fluctuation. Capital expenditures were $26.8 million during 2021, $12.2 million, 83.8%, higher than the prior year. Due to the economic conditions and uncertainty of future cash flows during the 2020 year, we only funded critical capital expenditure projects. In 2021, as the economy recovered we resumed our investments in capital projects. Capital expenditures for 2022 are forecasted to be approximately 3%-5% of sales, for investments in machinery and equipment for capacity expansion projects, improvements to manufacturing technology and maintaining/replacing existing machine capabilities.

Financing activities

Cash used in financing activities totaled $22.6 million in 2021, compared with cash provided by financing activities of $137.7 million in 2020.

Net repayments on our long-term non-revolving debt and revolving credit facilities in 2021 totaled $9.9 million as acquisition related borrowings of $56.7 million were more than offset by repayments during the year. In the 2020 year net borrowings on debt totaled $151.7 million, primarily for the acquisition of Balboa.

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Borrowings on our long-term non-revolving debt and our revolving credit facilities as of January 1, 2022 totaled $202.5 million and $243.0 million, respectively. See Note 10 of the Notes to the Consolidated Financial Statements included in this Annual Report for additional information regarding our credit facilities.

We have historically declared regular quarterly dividends to shareholders of $0.09 per share. We paid dividends totaling $11.6 million for the years ended January 1, 2022 and January 2, 2021. The declaration and payment of future dividends is subject to the sole discretion of the board of directors, and any determination as to the payment of future dividends will depend upon our profitability, financial condition, capital needs, acquisition opportunities, future prospects and other factors deemed pertinent by the board of directors.

Contractual obligations

Credit facilities

Information on our credit facilities, including future maturities, is presented in Note 10 of the Notes to the Consolidated Financial Statements included in this Annual Report. Our revolving credit facility with PNC Bank matures and is payable in full in October 2025; however, we may make earlier payments. Our term loan with PNC Bank is payable in quarterly installments of $3.8 million through 2023 and quarterly installments of $5.0 million thereafter through the maturity date of October 2025, at which time the remaining balance becomes due in full.

Interest rates on our credit facilities range from 2.0% to 5.3% as of January 1, 2022. Future interest payments are estimated to total $37.7 million, with annual payments ranging from $10.8 million to $7.8 million payable through the last maturity date of October 2025. Future payments assume the current interest rate environment, current currency exchange rates, future required payments on term loans and revolver borrowings consistent with January 1, 2022 debt levels. Future payments do not include an estimate of impacts from our derivative instruments.

Contingent consideration payments

Our contingent consideration liabilities total $6.4 million as of January 1, 2022. The balance represents the fair value estimate of contractual contingent payments related to our acquisitions of Balboa and NEM and are payable at various times through the first quarter of 2024.

Supplier purchase commitments

We enter into long-term commitments with key suppliers for minimum purchase quantities of inventory and we make commitments for capital expenditures. Obligations that are non-cancelable total $39.1 million, $43.3 million and $12.6 million for the 2022, 2023 and 2024 years, respectively.

Building purchase commitment

In 2020, the Company entered into a lease to buy agreement for the purchase of a building. We have the option to purchase the building at any time during the lease period and are committed to buy at the end of the 6-year lease term. The full purchase price is €26.7 million; however, the actual purchase price will be reduced by 60% of the payments made during the lease term.

Leases

We regularly enter into operating lease agreements for the use of machinery, equipment, vehicles, buildings and office space. Future maturities of our operating lease liabilities are presented in Note 7 of the Notes to the Consolidated Financial Statements included in this Annual Report.

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Critical Accounting Policies and Estimates

We prepare our Consolidated Financial Statements in conformity with U.S. GAAP, which requires management to make certain estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. Based on facts and circumstances inherent in developing estimates and assumptions, we believe it is unlikely that applying other such estimates and assumptions would have caused materially different amounts to have been reported. The following policies are considered by management to be the most critical in understanding the judgements, estimates and assumptions that are involved in the preparation of our Consolidated Financial Statements.

Business Combinations

Business combinations are accounted for under the acquisition method of accounting, which requires recognition separately from goodwill, the assets acquired and the liabilities assumed at their acquisition date fair values. Assigning fair market values to the assets acquired and liabilities assumed at the date of an acquisition requires knowledge of current market values, and the values of assets in use, and often requires the application of judgment regarding estimates and assumptions. While the ultimate responsibility resides with management, for certain acquisitions we retain the services of certified valuation specialists to assist with assigning estimated values to certain acquired assets and assumed liabilities, including intangible assets and tangible long-lived assets. Acquired intangible assets, excluding goodwill, are valued using various methodologies such as the discounted cash flow method, which is based on future cash flows specific to the type of intangible asset purchased and the relief from royalty method, which is based on the present value of savings resulting from the right to manufacture or sell products that incorporate the intangible asset without having to pay a license for its use. These methodologies incorporate various estimates and assumptions, the most significant being estimated royalty rates, projected revenue growth rates, profit margins and forecasted cash flows based on the discount rate.

Goodwill

Goodwill, which represents the excess of the purchase price of an acquisition over the fair value of the net assets acquired, is carried at cost. Goodwill is tested for impairment annually, in our third and fourth fiscal quarters, or more frequently if events or circumstances indicate a reduction in the fair value below the carrying value. The carrying value of assets is calculated at the reporting unit level. An impairment loss is recorded to the extent that the fair value of the goodwill within the reporting unit is less than its carrying value.

The assessment of fair value for impairment purposes requires significant judgment by management. We generally use a combination of market and income approach methodologies to estimate the fair value of our reporting units. The income approach is generally based on a discounted cash flow analysis, which estimates the present value of the projected free cash flows to be generated by the reporting unit. Assumptions used in the analysis include estimated future revenues and expenses, weighted average cost of capital, capital expenditures and other variables. Assumptions made for future cash flows are developed based on consideration of current and future economic conditions, recent sales trends, planned timing of product launches or other relevant variables. The market approach estimates the value of reporting units by comparing to guideline public companies or guideline transactions. Various valuation multiples of companies that are economically and operationally similar are used as data points for selecting multiples for the reporting units. Changes in assumptions or estimates could materially affect the estimated fair value of our reporting units and the potential for impairment.

Income Taxes

Our income tax policy provides for a balance sheet approach under which deferred income taxes are provided for based upon enacted tax laws and rates applicable to the periods in which the taxes become payable. These differences result from items reported differently for financial reporting and income tax purposes, primarily depreciation, amortization, accrued expenses and reserves.

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Our annual tax rate fluctuates based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective government taxing authorities. Significant judgment is required in determining our tax expense and in evaluating our tax positions, including evaluating uncertainties. We review our tax positions quarterly and adjust the balances as new information becomes available. Indefinite reinvestment is determined by management’s judgment about, and intentions concerning, our future operations.

We recognize and measure uncertain tax positions in accordance with ASC 740. We report a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. We file annual income tax returns in multiple taxing jurisdictions around the world. Many years may pass before an uncertain tax position is audited by the relevant tax authorities and finally resolved. While it is often difficult to predict the outcome or the timing of resolution of any particular uncertain tax position, we believe that our reserves for income taxes are adequate such that we reflect the benefits more likely than not to be sustained in an examination. We adjust these reserves, as well as the related interest and penalties, where appropriate in light of changing facts and circumstances. Settlement of any particular position could require the use of cash. We recognize interest and penalties, if any, related to unrecognized tax benefits in income tax expense.

See Note 12 of the Notes to the Consolidated Financial Statements included in this Annual Report for income tax amounts, including reserves.

Off Balance Sheet Arrangements

We do not engage in any off balance sheet financing arrangements. In particular, we do not have any material interest in variable interest entities, which include special purpose entities and structured finance entities.

Inflation

As more fully described above, we are experiencing supply shortages and increasing material and logistics costs. Continued increases in the global demand for the materials used in our products could result in significant increases in the costs of the components we purchase, and we may not be able to fully offset such higher costs through price increases. There is no assurance that our business will not be materially affected by inflation in the future.

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