# NOVANTA INC (NOVT) FY 2023 MD&A Verbatim Item 7 Management's Discussion and Analysis from NOVANTA INC's 10-K for fiscal year 2023. SEC filing source: https://www.sec.gov/Archives/edgar/data/1076930/000095017024021689/novt-20231231.htm Accession: 0000950170-24-021689 Filing date: 2024-02-28 Report date: 2023-12-31 Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture. Confidence: high Company profile: /company/NOVT/ All MD&A years: /company/NOVT/mda/ Previous year: /company/NOVT/mda/fy2022/ (FY 2022) Next year: /company/NOVT/mda/fy2024/ (FY 2024) Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the Consolidated Financial Statements and Notes included in Item 8 of this Annual Report on Form 10-K. The MD&A contains certain forward looking statements within the meaning of the United States Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. These forward-looking statements include, but are not limited to, our financial results and our financial condition; our belief that the Purchasing Managers Index may provide an indication of the impact of general economic conditions on our sales into the advanced industrial end market; our strategy; anticipated financial performance; expected liquidity and capitalization; drivers of revenue growth and our growth expectations in various markets; management’s plans and objectives for future operations, expenditures and product development, and investments in research and development; business prospects; potential of future product releases and expansion of our product and service offerings; anticipated revenue performance; industry trends; market conditions; our competitive positions; changes in economic and political conditions, including supply chain disruptions and constraints and inflationary pressures; changes in accounting principles; changes in actual or assumed tax liabilities; expectations regarding tax exposures; anticipated reinvestment of future earnings and dividend policy; anticipated expenditures in regard to the Company’s benefit plans; future acquisitions and integration and anticipated benefits from acquisitions and dispositions; anticipated economic benefits and expected costs of restructuring programs; ability to repay our indebtedness; our intentions regarding the use of cash; expectations regarding legal and regulatory requirements, including environmental requirements, and our compliance thereto; and other statements that are not historical facts. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various important factors, including those set forth in Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors.” The words “anticipates,” “believes,” “expects,” “intends,” “future,” “estimates,” “plans,” “could,” “would,” “should,” “potential,” “continues,” and similar words or expressions (as well as other words or expressions referencing future events, conditions or circumstances) identify forward looking statements. Readers should not place undue reliance on any such forward looking statements, which speak only as of the date they are made. Management and the Company disclaim any obligation to publicly update or revise any such statements to reflect any change in its expectations or in events, conditions, or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those contained in the forward looking statements, except as required under applicable law. Business Overview Novanta Inc. and its subsidiaries (collectively referred to as, the “Company”, “Novanta”, “we”, “us”, “our”) is a leading global supplier of core technology solutions that give medical and advanced industrial original equipment manufacturers (“OEMs”) a competitive advantage. We combine deep proprietary technology expertise and competencies in precision medicine, medical solutions and robotics and automation with a proven ability to solve complex technical challenges. This enables us to engineer core components and sub-systems that deliver extreme precision and performance, tailored to our customers' demanding applications. End Markets We primarily operate in two end markets: the medical market and the advanced industrial market. Medical Market For the year ended December 31, 2023, the medical market accounted for approximately 54% of our revenue. Revenue from our products sold to the medical market is generally affected by hospital and other healthcare provider capital spending, growth rates of surgical procedures, changes in regulatory requirements and laws, aggregation of purchasing by healthcare networks, changes in technology requirements, timing of OEM customers’ product development and new product launches, changes in customer or patient preferences, and general demographic trends. Advanced Industrial Market For the year ended December 31, 2023, the advanced industrial market accounted for approximately 46% of our revenue. Revenue from our products sold to the advanced industrial market is affected by a number of factors, including changing technology requirements and preferences of our customers, productivity or quality investments in a manufacturing environment, the financial condition of our customers, changes in regulatory requirements and laws, and general economic conditions. We believe that the Purchasing Managers Index on manufacturing activities specific to different regions around the world may provide an indication of the impact of general economic conditions on our sales into the advanced industrial market. 36 Strategy Our strategy is to drive sustainable, profitable growth through short-term and long-term initiatives, including: • disciplined focus on our diversified business model of providing functionality to long life-cycle OEM customer platforms in attractive medical and advanced industrial niche markets; • improving our business mix to increase medical sales as a percentage of total revenue by: - introducing new products aimed at attractive medical applications, such as minimally invasive and robotic surgery, ophthalmology, patient monitoring, drug delivery, clinical laboratory testing and life science equipment; - deepening our key account management relationships with and driving cross selling of our product offerings to leading medical equipment manufacturers; and - pursuing complementary medical technology acquisitions; • increasing our penetration of high growth advanced industrial applications, such as laser materials processing, intelligent end-of-arm robotic technology solutions, robotics, laser additive manufacturing, automation and metrology, by working closely with OEM customers to launch application specific products that closely match the requirements of each application; • broadening our portfolio of enabling proprietary technologies and capabilities through increased investment in new product development, and investments in application development to further penetrate existing customers, while expanding the applicability of our solutions to new markets; • broadening our product and service offerings through the acquisition of innovative and complementary technologies and solutions in medical and advanced industrial technology applications; • expanding sales and marketing channels to reach new target customers; • improving our existing operations to expand profit margins and improve customer satisfaction by implementing lean manufacturing principles, strategic sourcing across our major production sites, and optimizing and limiting the growth of our fixed cost base; and • attracting, retaining, and developing world-class talented, diverse, and motivated employees. Significant Events and Updates Acquisition of Motion Solutions On January 2, 2024, we completed the acquisition of Motion Solutions Parent Corp. (“Motion Solutions”), an Irvine, California-based provider of highly engineered integrated solutions, specializing in proprietary precision motion and advanced motion control solutions, for a total purchase price of $192.2 million in cash, subject to customary closing and net working capital adjustments. Motion Solutions acquisition will be included in our Medical Solutions reportable segment. Business Environment Inflationary Pressures In 2023, we continued to experience higher than normal inflation of raw materials and component prices and labor costs. We have generally been able to offset increases in these costs through various productivity cost reduction initiatives, as well as increasing our selling prices to pass through some of these higher costs to our customers. However, our ability to raise our selling prices depends on market conditions and competitive dynamics. Given the timing of our actions compared to the timing of these inflationary pressures, there may be periods during which we are unable to fully recover the increases in our costs. Additionally, the inflationary pressures have given rise to significant increases in interest rates as various governments used monetary policy to contain and reduce inflation. As a result, our weighted average interest rate increased from approximately 5.1% as of December 31, 2022 to approximately 6.2% as of December 31, 2023. Geopolitical Conflicts In February 2022, Russian forces invaded Ukraine. In response, the U.S., the European Union (“EU”), and several other countries imposed economic and trade sanctions and other restrictions (collectively, “global sanctions”) targeting Russia and Belarus. Russia then imposed retaliatory economic measures against the U.S., the EU, and several other countries. Our historical sales to Russia were not material. We also do not have any assets, employees or third-party contractors in Russia or Ukraine. However, the duration of the conflict and further sanctions could have further impact on the global economy and inflation. 37 In early October 2023, Israel declared war on Hamas after the Palestinian militant group launched a surprise cross-border raid in Israel. We are monitoring the social, political and economic environment in Israel and in the region for any impact on our businesses. Our historical sales to Israel were around 1% of our total sales. We do not have any assets, employees, or third-party contractors in Israel. Due to the uncertainty around the duration of the conflict, future impacts are unknown to our businesses. Overview of Financial Results Total revenue for 2023 was $881.7 million, an increase of $20.8 million, or 2.4%, versus 2022. This increase was primarily due to increased demand in the medical markets and revenue from a prior year acquisition. The effect of our prior year acquisition resulted in an increase in revenue of $8.1 million, or 0.9%. In addition, foreign exchange rates favorably impacted our revenue by $1.3 million, or 0.2%, in 2023. Operating income for 2023 was $110.5 million, an increase of $7.4 million, or 7.2%, versus 2022. This increase was primarily attributable to an increase in gross profit of $21.4 million primarily attributable to higher revenue and a decrease in amortization expense of $5.9 million, partially offset by an increase in restructuring, acquisition and related charges of $8.4 million, research and development and engineering (“R&D”) expenses of $5.9 million, and selling, general and administrative (“SG&A”) expenses of $5.6 million. Basic earnings per common share (“basic EPS”) of $2.03 in 2023 decreased $0.05 from the basic EPS of $2.08 in 2022. Diluted earnings per common share (“diluted EPS”) of $2.02 in 2023 decreased $0.04 from the diluted EPS of $2.06 in 2022. The decreases in basic EPS and diluted EPS were primarily attributable to an increase in interest expense, partially offset by an increase in operating income and a decrease in income tax provision. Specific components of our operating results for 2023 and 2022 are further discussed below. Results of Operations Information pertaining to fiscal year 2021 results of operations, including a year-over-year comparison with fiscal year 2022, was included in our Annual Report on Form 10-K for the year ended December 31, 2022 under Part II, Item 7, “Management’s Discussion and Analysis of Financial Position and Results of Operations,” which was filed with the SEC on March 1, 2023. The following table sets forth external revenue by reportable segment for 2023 and 2022 (dollars in thousands): [[GREPCENT_TABLE]] [["","","","","","","","% Change"],["","2023","","","2022","","","2023 vs. 2022"],["Precision Medicine and Manufacturing","$","282,971","","","$","274,674","","","","3.0","%"],["Medical Solutions","","325,221","","","","277,992","","","","17.0","%"],["Robotics and Automation","","273,470","","","","308,237","","","","(11.3",")%"],["Total","$","881,662","","","$","860,903","","","","2.4","%"]] [[/GREPCENT_TABLE]] Precision Medicine and Manufacturing Precision Medicine and Manufacturing segment revenue in 2023 increased by $8.3 million, or 3.0%, versus 2022, primarily due to increased demand in the medical markets. Medical Solutions Medical Solutions segment revenue in 2023 increased by $47.2 million, or 17.0%, versus 2022, primarily due to increases in sales from our minimally invasive surgery products and detection and analysis products, and $8.1 million of revenue contributions from our 2022 acquisition. Robotics and Automation Robotics and Automation segment revenue in 2023 decreased by $34.8 million, or 11.3%, versus 2022, primarily due to a decrease in demand in advanced industrial markets, driven by microelectronics markets. 38 Gross Profit The following table sets forth the gross profit and gross profit margin for each of our reportable segments for 2023 and 2022 (dollars in thousands): [[GREPCENT_TABLE]] [["","2023","","","2022"],["Gross profit:"],["Precision Medicine and Manufacturing","$","139,060","","","$","129,173"],["Medical Solutions","","135,640","","","","108,713"],["Robotics and Automation","","130,885","","","","146,150"],["Unallocated Corporate and Shared Services","","(5,688",")","","","(5,564",")"],["Total","$","399,897","","","$","378,472"],["Gross profit margin:"],["Precision Medicine and Manufacturing","","49.1","%","","","47.0","%"],["Medical Solutions","","41.7","%","","","39.1","%"],["Robotics and Automation","","47.9","%","","","47.4","%"],["Total","","45.4","%","","","44.0","%"]] [[/GREPCENT_TABLE]] Gross profit and gross profit margin can be influenced by a number of factors, including product mix, pricing, volume, manufacturing efficiencies and utilization, costs for raw materials and outsourced manufacturing, headcount, inventory obsolescence and warranty expenses. Precision Medicine and Manufacturing Precision Medicine and Manufacturing segment gross profit for 2023 increased $9.9 million, or 7.7%, versus 2022, primarily due to an increase in both revenue and gross profit margin. Precision Medicine and Manufacturing segment gross profit margin was 49.1% for 2023, versus a gross profit margin of 47.0% for 2022. The increase in gross profit margin was primarily attributable to improved factory productivity, favorable product mix and the impact of business interruption insurance recovery payments, partially offset by an increase in inventory reserves as a result of a demand decline in the advanced industrial market and higher cost of poor quality. Medical Solutions Medical Solutions segment gross profit for 2023 increased $26.9 million, or 24.8%, versus 2022, primarily due to an increase in both revenue and gross profit margin. Medical Solutions segment gross profit margin was 41.7% for 2023, compared with a gross profit margin of 39.1% for 2022. The increase in gross profit margin was primarily attributable to improved factory efficiency. Robotics and Automation Robotics and Automation segment gross profit for 2023 decreased $15.3 million, or 10.4%, versus 2022, primarily due to a decrease in revenue. Robotics and Automation segment gross profit margin was 47.9% for 2023, compared with a gross profit margin of 47.4% for 2022. The increase in gross profit margin was primarily attributable to improved factory efficiency and disciplined cost control. Operating Expenses The following table sets forth operating expenses for 2023 and 2022 (dollars in thousands): [[GREPCENT_TABLE]] [["","","","","","","","% Change"],["","2023","","","2022","","","2023 vs. 2022"],["Research and development and engineering","$","91,682","","","$","85,770","","","","6.9","%"],["Selling, general and administrative","","164,460","","","","158,901","","","","3.5","%"],["Amortization of purchased intangible assets","","20,445","","","","26,338","","","","(22.4",")%"],["Restructuring, acquisition and related costs","","12,814","","","","4,384","","","","192.3","%"],["Total","$","289,401","","","$","275,393","","","","5.1","%"]] [[/GREPCENT_TABLE]] 39 Research and Development and Engineering Expenses Research and development and engineering (“R&D”) expenses are primarily comprised of employee compensation and related expenses and cost of materials for R&D projects. R&D expenses were $91.7 million, or 10.4% of revenue, in 2023, versus $85.8 million, or 10.0% of revenue, in 2022. R&D expenses increased in terms of total dollars primarily due to higher compensation related expenses. Selling, General and Administrative Expenses Selling, general and administrative (“SG&A”) expenses include costs for sales and marketing, sales administration, finance, human resources, legal, information systems and executive management. SG&A expenses were $164.5 million, or 18.7% of revenue, in 2023, versus $158.9 million, or 18.5% of revenue, in 2022. SG&A expenses increased in terms of total dollars and as a percentage of revenue primarily due to increases in compensation related expenses and discretionary spending. Amortization of Purchased Intangible Assets Amortization of purchased intangible assets is charged to our Precision Medicine and Manufacturing, Medical Solutions and Robotics and Automation segments. Amortization of developed technologies is included in cost of revenue in the consolidated statement of operations. Amortization of customer relationships, trademarks, trade names, backlog and other intangibles are included in operating expenses in the consolidated statement of operations. Amortization of purchased intangible assets, excluding the amortization of developed technologies that is included in cost of revenue, was $20.4 million, or 2.3% of revenue, in 2023, versus $26.3 million, or 3.1% of revenue, in 2022. The decrease, in terms of total dollars and as a percentage of revenue was primarily due to certain intangible assets being fully amortized in 2022. Restructuring, Acquisition and Related Costs Restructuring, acquisition and related charges primarily relate to our restructuring programs, acquisition related costs incurred for completed acquisitions, acquisition costs related to future potential acquisitions and failed acquisitions, and changes in fair value of contingent considerations. We recorded restructuring, acquisition and related costs of $12.8 million in 2023, versus $4.4 million in 2022. The restructuring costs increased $7.4 million primarily related to an increase of severance and related costs and facility costs associated with the closure of a small manufacturing facility to improve efficiencies. Operating Income (Loss) by Segment The following table sets forth operating income (loss) by segment for 2023 and 2022 (in thousands): [[GREPCENT_TABLE]] [["","2023","","","2022"],["Operating Income (Loss)"],["Precision Medicine and Manufacturing","$","69,283","","","$","63,760"],["Medical Solutions","","41,883","","","","28,244"],["Robotics and Automation","","48,373","","","","60,294"],["Unallocated Corporate and Shared Services","","(49,043",")","","","(49,219",")"],["Total","$","110,496","","","$","103,079"]] [[/GREPCENT_TABLE]] Precision Medicine and Manufacturing Precision Medicine and Manufacturing segment operating income was $69.3 million, or 24.5% of revenue, in 2023, versus $63.8 million, or 23.2% of revenue, in 2022. The increase in operating income was primarily due to an increase in gross profit of $9.9 million, partially offset by an increase in restructuring, acquisition, and related costs of $3.2 million and an increase in SG&A expenses of $1.6 million. 40 Medical Solutions Medical Solutions segment operating income was $41.9 million, or 12.9% of revenue, in 2023, versus $28.2 million, or 10.2% of revenue, in 2022. The increase in operating income was primarily due to an increase in gross profit of $26.9 million and a decrease in amortization expenses of $1.0 million, partially offset by an increase in R&D spending of $8.5 million, an increase in SG&A expenses of $5.0 million and an increase in restructuring, acquisition and related costs of $0.8 million. Robotics and Automation Robotics and Automation segment operating income was $48.4 million, or 17.7% of revenue, in 2023, versus $60.3 million, or 19.6% of revenue, in 2022. The decrease in operating income was primarily due to a decrease in gross profit of $15.3 million, and an increase in restructuring, acquisition and related costs of $3.8 million, partially offset by a decrease in SG&A expenses of $0.7 million, a decrease in R&D spending of $1.8 million and a decrease in amortization of purchased intangible assets of $4.7 million. Unallocated Corporate and Shared Services Unallocated corporate and shared services costs primarily represent costs of corporate and shared SG&A functions and other public company costs that are not allocated to the operating segments, including certain restructuring and most acquisition related costs. Unallocated corporate and shared services costs for 2023 decreased by $0.2 million, or 0.4%, from 2022. Interest Income (Expense), Foreign Exchange Transaction Gains (Losses), and Other Income (Expense), Net The following table sets forth interest income (expense), foreign exchange transaction gains (losses), and other income (expense) for 2023 and 2022 (in thousands): [[GREPCENT_TABLE]] [["","2023","","","2022"],["Interest income (expense), net","$","(25,818",")","","$","(15,616",")"],["Foreign exchange transaction gains (losses), net","$","(255",")","","$","67"],["Other income (expense), net","$","(675",")","","$","(371",")"]] [[/GREPCENT_TABLE]] Interest Income (Expense), Net Net interest expense was $25.8 million in 2023 versus $15.6 million in 2022. The increase in net interest expense was primarily due to an increase in the weighted average interest rate, partially offset by a decrease in average debt levels under our senior credit facilities. The weighted average interest rate on our outstanding debt was 6.21% and 3.24% during 2023 and 2022, respectively. Included in net interest expense was non-cash interest expense of approximately $1.2 million for both 2023 and 2022, related to the amortization of deferred financing costs on our debt. Foreign Exchange Transaction Gains (Losses), Net Foreign exchange transaction gains (losses) were nominal in both 2023 and 2022. Other Income (Expense), Net Net other expenses were nominal in both 2023 and 2022. Income Tax Provision We recorded a tax provision of $10.9 million in 2023, compared to a tax provision of $13.1 million in 2022. The effective tax rate for 2023 was 13.0% of income before income taxes, compared to an effective tax rate of 15.0% of income before income taxes for 2022. Our effective tax rate for 2023 differed from the Canadian statutory rate of 29.0% primarily due to the mix of income earned in jurisdictions with varying tax rates, $4.5 million benefit for foreign derived intangible income, $4.2 million benefit from U.K. patent box deductions and $3.6 million benefit from R&D and other tax credits, partially offset by $2.1 million increase in valuation allowances and a $2.6 million detriment related to disallowed compensation. We recorded a tax provision of $13.1 million in 2022. The effective tax rate for 2022 was 15% of income before income taxes. Our effective tax rate for 2022 differed from the Canadian statutory rate of 29.0% primarily due to the mix of income earned in jurisdictions with varying tax rates, $4.5 million benefit for foreign derived intangible income, $3.1 million benefit from U.K. patent 41 box deductions and $2.3 million benefit from R&D and other tax credits, partially offset by $2.0 million increase in valuation allowances and a $2.1 million detriment related to disallowed compensation. The Organisation for Economic Co-operation and Development (“OECD”) published a framework to implement a global corporate minimum income tax rate of 15% on income arising in low-tax jurisdictions (often referred to as “Pillar Two”). The Pillar Two proposed legislation is applicable to multinational corporations with global revenue exceeding €750 million ($820 million). Over 140 countries have agreed in principle to implement Pillar Two and many have, or are in the process of, enacting related legislation. We expect to meet the Pillar Two revenue threshold in 2024. The U.S. has not enacted the rules. Certain of the major jurisdictions where we operate have indicated that they will implement Pillar Two, but have not yet enacted legislation. Due to the uncertainty of whether the U.S. and other countries will enact the rules, the timing of individual country legislative action and the underlying complexity of the rules, the impact, if any, on the Company's tax obligations and income tax rate is not reasonably estimable at this time. Net Income Net income was $72.9 million for the year ended December 31, 2023, compared to $74.1 million for the year ended December 31, 2022, reflecting the impact of the factors described above. Liquidity and Capital Resources We assess our liquidity in terms of our ability to generate cash to fund our operating, investing, and financing activities. Our primary ongoing cash requirements are funding operations, capital expenditures, investments in businesses, and repayment of debt and related interest payments. Our primary sources of liquidity are cash flows from operations and borrowings under our revolving credit facility. We believe our future operating cash flows will be sufficient to meet our future operating and capital expenditure cash needs for the foreseeable future, including at least the next 12 months. The availability of borrowing capacity under our revolving credit facility provides another potential source of liquidity for any future capital expenditures and other liquidity needs. In addition, we have the ability to expand our borrowing capacity by up to $350.0 million by exercising the accordion feature under our revolving credit agreement. We may seek to raise additional capital, which could be in the form of bonds, convertible debt or preferred or common equity, to fund business development activities or other future investing cash requirements, subject to approval by the lenders in the Third Amended and Restated Credit Agreement. There is no assurance that such capital will be available on reasonable terms or at all. Significant factors affecting the management of our ongoing cash requirements are the adequacy of available bank lines of credit and our ability to attract long-term capital with satisfactory terms. The sources of our liquidity are subject to all of the risks of our business and could be adversely affected by, among other factors, risks associated with events outside of our control, such as economic consequences of global pandemics and geopolitical conflicts, prolonged supply chain disruptions and electronics and other material shortages, a decrease in demand for our products, our ability to integrate current and future acquisitions, deterioration in certain financial ratios, availability of borrowings under our revolving credit facility, and market changes in general. See “Risks Relating to Our Common Shares and Our Capital Structure” included in Item 1A of this Annual Report on Form 10-K. Our ability to make payments on our indebtedness and to fund our operations may be dependent upon the operating income and the distribution of funds from our subsidiaries. However, as local laws and regulations and/or the terms of our indebtedness restrict certain of our subsidiaries from paying dividends and transferring assets to us, there is no assurance that our subsidiaries will be permitted to provide us with sufficient dividends, distributions or loans when necessary. As of December 31, 2023, $62.6 million of our $105.1 million of cash and cash equivalents was held by our subsidiaries outside of North America. Generally, our intent is to use cash held in these foreign subsidiaries to fund our local operations or acquisitions by those local subsidiaries and to pay down borrowings under our senior credit facilities. Approximately $126.1 million of our outstanding borrowings under our senior credit facilities were held in our subsidiaries outside of North America as of December 31, 2023. Additionally, we may use intercompany loans to address short-term cash flow needs from various subsidiaries. In May 2021, our shareholders approved a special resolution to amend the Company’s articles to authorize up to 7.0 million preferred shares for future issuance. Our Board of Directors may designate and issue one or more series of preferred shares in order to raise additional capital, provided that no shares of any series may be entitled to more than one vote per share. As of December 31, 2023, no preferred shares were issued and outstanding. 42 Share Repurchase Plans Our Board of Directors may approve share repurchase plans from time to time. Under these repurchase plans, shares may be repurchased at our discretion based on ongoing assessment of the capital needs of the business, the market price of our common shares, and general market conditions. Shares may also be repurchased through an accelerated share purchase agreement, on the open market or in privately negotiated transactions in accordance with applicable federal securities laws. Repurchases may be made under certain SEC regulations, which would permit common shares to be repurchased when we would otherwise be prohibited from doing so under insider trading laws. While the share repurchase plans are generally intended to offset dilution from equity awards granted to our employees and directors, the plans do not obligate us to acquire any particular amount of common shares. No time limit is typically set for the completion of the share repurchase plans, and the plans may be suspended or discontinued at any time. We expect to fund share repurchases through cash on hand and cash generated from operations. In February 2020, our Board of Directors approved a new share repurchase plan (the “2020 Repurchase Plan”) authorizing the repurchase of $50.0 million worth of common shares, effective after our prior repurchase plan was completed. Share repurchases have been made under the 2020 Repurchase Plan pursuant to Rule 10b-18 under the Securities Exchange Act of 1934. During the year ended December 31, 2022, we repurchased 4 thousand shares for an aggregate purchase price of $0.5 million at an average price of $116.95 per share under the 2020 Repurchase Plan. No shares were repurchased during the three months or the year ended December 31, 2023. As of December 31, 2023, we had $49.5 million available for share repurchases under the 2020 Repurchase Plan. Senior Credit Facilities In December 2019, we entered into the Third Amended and Restated Credit Agreement, originally consisting of a $100.0 million U.S. dollar equivalent euro-denominated (approximately €90.2 million) 5-year term loan facility and a $350.0 million 5-year revolving credit facility (collectively, the “Senior Credit Facilities”). The term loan facility requires quarterly scheduled principal repayments of approximately €1.1 million that began in March 2020 with the remaining principal balance due upon maturity. We may make additional principal payments at any time, which will reduce the next quarterly installment payment due. We may pay down our revolving credit facility with cash on hand and cash generated from future operations at any time until maturity. On March 27, 2020, we entered into an amendment (the “First Amendment”) to the Third Amended and Restated Credit Agreement and exercised a portion of the uncommitted accordion feature. The First Amendment increased the revolving credit facility commitment under the Third Amended and Restated Credit Agreement by $145.0 million, from $350.0 million to $495.0 million, and reset the uncommitted accordion feature to $200.0 million for potential future expansion. On June 2, 2020, we entered into an amendment (the “Second Amendment”) to the Third Amended and Restated Credit Agreement. The Second Amendment revised our consolidated leverage ratio definition (as defined in the Third Amended and Restated Credit Agreement) allowing for the use of up to $25 million unrestricted cash and cash equivalents as a reduction to consolidated funded indebtedness (as defined in the Third Amended and Restated Credit Agreement). On October 5, 2021, we entered into an amendment (the “Fourth Amendment”) to the Third Amended and Restated Credit Agreement to exercise the accordion feature. The Fourth Amendment increased the revolving credit facility commitment under the Third Amended and Restated Credit Agreement by $200.0 million, from $495.0 million to $695.0 million, and reset the uncommitted accordion feature to $200.0 million for potential future expansion. On March 10, 2022, the Company entered into an amendment (the “Fifth Amendment”) to the Third Amended and Restated Credit Agreement to extend the maturity date thereof from December 31, 2024 to March 10, 2027, update the pricing grid, replace LIBOR with SOFR as the reference rate for U.S. dollar borrowings, and increase the uncommitted accordion feature from $200.0 million to $350.0 million. As of December 31, 2023, we had $79.6 (€72.1) million term loan and $278.4 million revolver borrowings outstanding under our Senior Credit Facilities. On January 2, 2024, we drew down on our revolving credit facility to fund the acquisition of Motion Solutions Parent Corp. The borrowings outstanding under the Senior Credit Facilities bear interest at rates based on (a) the Base Rate, as defined in the Third Amended and Restated Credit Agreement, plus a margin ranging between 0.00% to 0.75% per annum, determined by reference to our consolidated leverage ratio, or (b) the Term SOFR Screen Rate, the Alternative Currency Daily Rate or the Alternative Currency Term Rate, as defined in the Third Amended and Restated Credit Agreement, plus a margin ranging between 0.75% and 1.75% per annum, determined by reference to our consolidated leverage ratio. In addition, we are obligated to pay a commitment fee on the unused portion of the revolving credit facility, ranging between 0.20% and 0.30% per annum, determined by reference to our consolidated leverage ratio. As of December 31, 2023, we had outstanding borrowings under the Third Amended and Restated Credit Agreement denominated in Euro and U.S. Dollars of $126.1 million and $232.0 million, respectively. 43 The Third Amended and Restated Credit Agreement contains various covenants that, we believe, are usual and customary for this type of agreement, including a maximum allowed leverage ratio and a minimum required fixed charge coverage ratio (as defined in the Third Amended and Restated Credit Agreement). The following table summarizes these financial covenants and our compliance therewith as of December 31, 2023: [[GREPCENT_TABLE]] [["","Requirement","","Actual as of December 31, 2023"],["Maximum consolidated leverage ratio (1)","3.50","","1.70"],["Minimum consolidated fixed charge coverage ratio","1.50","","4.67"]] [[/GREPCENT_TABLE]] (1) Maximum consolidated leverage ratio shall be increased to 4.00 for four consecutive quarters following a designated acquisition, as defined in the Fifth Amendment. In addition, the Third Amended and Restated Credit Agreement contains various other customary representations, warranties and covenants applicable to the Company and its subsidiaries, including: (i) limitations on certain payments; (ii) limitations on fundamental changes involving the Company; (iii) limitations on the disposition of assets; and (iv) limitations on indebtedness, investments, and liens. Cash Flows Cash and cash equivalents totaled $105.1 million as of December 31, 2023, versus $100.1 million as of December 31, 2022. The net increase in cash and cash equivalents is primarily attributable to cash provided by operating activities of $120.1 million, partially offset by $86.6 million of debt repayments, $20.0 million of capital expenditures, and $10.6 million of payroll withholding tax payments related to net share settlement upon vesting of share-based compensation awards. The following table summarizes our cash and cash equivalent balances, cash flows and unused borrowing capacity available under our revolving credit facility for the years indicated (in thousands): [[GREPCENT_TABLE]] [["","2023","","","2022"],["Cash and cash equivalents, end of year","$","105,051","","","$","100,105"],["Net cash provided by operating activities","$","120,075","","","$","90,779"],["Net cash used in investing activities","$","(19,892",")","","$","(42,541",")"],["Net cash provided by (used in) financing activities","$","(97,853",")","","$","(60,154",")"],["Unused borrowing capacity available under the revolving credit facility, end of year","$","416,596","","","$","336,587"]] [[/GREPCENT_TABLE]] Operating Cash Flows Cash provided by operating activities was $120.1 million in 2023, versus $90.8 million in 2022. Cash provided by operating activities increased from 2022 primarily as a result of higher operating income and less cash outflows from changes in net working capital, partially offset by higher income tax payments and higher interest payments. Investing Cash Flows Cash used in investing activities was $19.9 million in 2023, primarily related to capital expenditures of $20.0 million. Cash used in investing activities was $42.5 million in 2022, primarily driven by the $22.4 million of cash consideration (net of cash acquired) paid for the acquisition of MPH Medical Devices S.R.O. ("MPH"). We also paid capital expenditures of $19.6 million and a contingent consideration payment of $1.5 million related to our 2016 asset acquisition of video signal processing and management technologies. We received $0.8 million net working capital adjustment in 2022 related to our ATI acquisition. We have no material commitments to purchase property, plant and equipment as of December 31, 2023. We expect to use approximately $20 million to $25 million in 2024 for capital expenditures related to investments in new property, plant and equipment for our existing businesses, which includes a significant one-time facility buildout project in the U.K. that began in 2023 with target completion in 2024. This project is one quarter behind schedule, causing capital expenditures previously budgeted in 2023 to move into 2024. Financing Cash Flows Cash used in financing activities was $97.9 million in 2023, primarily due to $86.6 million of term loan and revolving credit facility repayments and $10.6 million of payroll withholding tax payments related to net share settlement upon vesting of share-based compensation awards. 44 Cash used in financing activities was $60.2 million in 2022, primarily due to $59.0 million of term loan and revolving credit facility repayments, $46.3 million of contingent consideration payments related to prior year acquisitions, $11.7 million of payroll withholding tax payments related to net share settlement upon vesting of share-based compensation awards, $10.0 million of repurchases of common shares, and $2.5 million of debt issuance costs in connection with the Fifth Amendment, partially offset by $69.9 million of borrowings under our revolving credit facility used to fund the contingent consideration paid for the ATI acquisition and the cash consideration paid for the MPH acquisition. In 2024, we are contractually required to make $5.0 million in repayments under our term loan facility. In addition, we may make optional repayments under our revolving credit facility from time to time with available cash generated from future operating activities. Other Liquidity Matters Pension Plans We maintain a defined benefit pension plan (the “U.K. Plan”) in Novanta Technologies U.K. Limited, a wholly owned subsidiary of the Company. Our U.K. Plan was closed to new members in 1997 and stopped accruing additional pension benefits for existing members in 2003, thereby limiting our obligation to benefits earned through that date. Benefits under this plan were based on the participants’ years of service and compensation as of the date the plan was frozen, adjusted for inflation. On July 1, 2013, the Company provided a Guarantee (the “Guarantee”) in favor of the trustees of the U.K. Plan with respect to all present and future obligations and liabilities (whether actual or contingent and whether owed jointly or severally and in any capacity whatsoever) under the U.K. Plan. Our funding policy is to fund the U.K. Plan based on actuarial methods as permitted by the Pensions Regulator in the U.K. The results of funding valuations depend on both the funding deficit and the assumptions used, such as asset returns, discount rates, mortality rates, retail price inflation and other market driven assumptions. Each assumption used represents one estimate of many possible future outcomes. The final cost to us will be determined by events as they actually become known, including actual return on plan assets and pension payments to plan participants. As of December 31, 2023, the fair value of plan assets exceeded the projected benefit obligation under the U.K. Plan by $3.1 million. Based on the results of the most recent funding valuation in 2021, we are expected to contribute an additional approximately $0.3 million by March 31, 2024. Future annual funding contributions will be determined in the next statutory funding valuation date to be completed in 2024. Material Cash Requirements Senior Credit Facilities As of December 31, 2023, we had $79.6 million (€72.1 million) term loan and $278.4 million revolving credit facility borrowings outstanding under the Senior Credit Facilities. On January 2, 2024, we drew down on our revolving credit facility under the Senior Credit Facilities to fund the acquisition of Motion Solutions Parent Corp. The term loan is payable in quarterly installments of approximately €1.1 million ($1.2 million) with the final installment of €58.5 million ($64.7 million) due upon maturity in March 2027. Borrowings under the revolving credit facility are due at maturity in March 2027. As of December 31, 2023, the future interest payments under our Senior Credit Facilities are expected to be approximately $72.0 million through maturity based on the current contractual term, with $23.0 million payable within the next twelve months. These estimates are based on current interest rates on floating rate obligations, as defined in the Third Amended and Restated Credit Agreement, for the remainder of the contractual life of both the term loan and outstanding borrowings under the revolving credit facility, and the current commitment fee rate was used for the unused commitments under the revolving credit facility as of December 31, 2023. These estimates also assume only quarterly term loan payments are made and outstanding revolving credit facility remains unchanged throughout the contractual term. The actual interest payments will vary due to changes in our debt level and interest rate. See Note 11, “Debt,” in the Consolidated Financial Statements for further details of our debt obligations and the timing of expected future payments. Operating and Finance Leases We have entered into various lease agreements for office and manufacturing facilities, vehicles, and equipment used in the normal course of business. Undiscounted operating and finance lease obligations were $61.3 million, with $10.7 million payable within the next twelve months. See Note 12, “Leases,” in the Consolidated Financial Statements for further details of our obligations and the timing of expected future payments. 45 Purchase Obligations Purchase obligations represent an estimate of all open purchase orders and contractual obligations in the ordinary course of business for which we have not received the goods or services. As of December 31, 2023, we had $127.5 million of purchase obligations, with $119.7 million payable within the next twelve months. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the dates of the financial statements and the reported amounts of revenues and expenses for the reporting periods. On an ongoing basis, we evaluate our estimates, assumptions and judgments, including those related to revenue recognition, inventory valuation, impairment assessment and valuation of goodwill, intangible assets and tangible long-lived assets, valuation of contingent consideration obligations, accounting for income taxes, and accounting for loss contingencies. Actual results in the future could differ significantly from our estimates. We believe that the following critical accounting policies and estimates most significantly affect the portrayal of our financial condition and results of operations and require the most difficult and subjective judgments. Revenue Recognition. We recognize revenue in accordance with Accounting Standards Codification (“ASC”) 606, “Revenue from Contracts with Customers”. We recognize revenue when control of promised goods or services is transferred to customers. This generally occurs upon shipment when the title and risk of loss pass to the customer. The vast majority of our revenue is generated from the sale of distinct products. Revenue is measured as the amount of consideration we expect to receive in exchange for such products, which is generally at contractually stated prices. Sales taxes and value added taxes collected concurrently with revenue generating activities are excluded from revenue. Substantially all of our revenue is recognized at a point in time, upon shipment, rather than over time. At the request of our customers, we may perform professional services, generally for the maintenance and repair of products previously sold to those customers and for engineering services. Professional services are less than 3% of our consolidated revenue. Revenue is typically recognized at a point in time when control transfers to the customer upon completion of professional services. These services generally involve a single distinct performance obligation. The consideration expected to be received in exchange for such services is normally the contractually stated amount. We occasionally sell separately priced non-standard/extended warranty services or preventative maintenance plans with the sale of products. The transfer of control over the service plans is over time. We recognize the related revenue ratably over the terms of the service plans. The transaction price of a contract is allocated to each performance obligation based on its relative standalone selling price. Standalone selling prices are generally determined based on the prices charged to customers or using the expected cost plus a margin. We account for shipping and handling activities that occur after the transfer of control over the related goods as fulfillment activities rather than performance obligations. The shipping and handling fees charged to customers are recognized as revenue and the related costs are recorded in cost of revenue at the time of transfer of control. We generally provide warranties for our products. The standard warranty period is typically 12 months to 36 months. The standard warranty period for product sales is accounted for under the provisions of ASC 450, “Contingencies,” as we have the ability to ascertain the likelihood of the liability and can reasonably estimate the amount of the liability. A provision for the estimated cost related to warranty is recorded to cost of revenue at the time revenue is recognized. Our estimate of the costs to service warranty obligations is based on historical experience and expectations of future conditions. To the extent our experience in warranty claims or costs associated with servicing those claims differ from the original estimates, revisions to the estimated warranty liability are recorded at that time, with an offsetting entry recorded to cost of revenue. We expense incremental direct costs of obtaining a contract when incurred if the expected amortization period is one year or less. These costs are recorded within selling, general and administrative expenses in the consolidated statement of operations. We do not adjust the promised amount of consideration for the effects of a financing component because the time period between the transfer of a promised good to a customer and the customer’s payment for that good is typically one year or less. Inventories. Inventories, which include materials and conversion costs, are stated at the lower of cost or net realizable value, using the first-in, first-out method. We regularly review inventory quantities on hand and, when necessary, record provisions for excess and obsolete inventory based on either our forecasted product demand and production requirements or trailing historical usage of the product. If our sales do not materialize as previously forecasted or at historical levels, we may have to increase our reserve for excess and obsolete inventory, which would reduce our operating income. If actual market conditions are more favorable than 46 anticipated, inventory previously written down may be sold, resulting in lower cost of revenue and higher operating income than expected in that period. Share-Based Compensation. We record expenses associated with share-based compensation awards to employees and directors based on the fair value of awards as of the grant date. In addition to service-based awards granted to a wider employee base and stock options granted to certain members of the executive management team, we typically grant three types of performance-based awards to certain members of the executive management team: performance-based restricted stock units with company-specific financial performance conditions (“attainment-based PSUs”), performance-based restricted stock units with market-based performance conditions (“market-based PSUs”), and performance-based restricted stock units with a hybrid of company financial metrics and market-based performance conditions (“hybrid PSUs”). For share-based compensation awards that vest over time based on employment, the associated expenses are recognized in the consolidated statement of operations ratably over the vesting period of the awards, net of estimated forfeitures determined based on historical forfeiture experience. For stock options, share-based compensation expenses are recognized based on the fair value of the stock options, which is determined using the Black-Scholes option pricing model as of the date of grant. Shared-based compensation expenses related to stock options are recognized on a straight-line basis ratably over the vesting period of the awards. Black-Scholes option pricing model includes various assumptions, including the expected term of the award, the expected volatility of our common shares and the expected risk-free interest rate over the expected term of the award, expected dividend payments, and the fair value of our common shares. For attainment-based PSUs, share-based compensation expenses are recognized based on the closing price of our common shares on the date of grant ratably over the vesting period when it is probable that specified performance targets are expected to be achieved based on management’s projections as of the end of each period. Management’s projections are revised, if necessary, in subsequent periods when underlying factors change the estimated probability of achieving the performance targets as well as the levels of achievement. When the estimated achievement levels are adjusted at a later date, a cumulative adjustment to the share-based compensation expense previously recognized would be required. Accordingly, share-based compensation expenses associated with attainment-based PSUs may differ significantly from period to period based on changes to both the probability and the level of achievement against the specified performance targets. For market-based PSUs, share-based compensation expenses are recognized based on the fair value of the market-based PSUs, which is determined using the Monte-Carlo simulation valuation model as of the date of grant. Shared-based compensation expenses related to market-based PSUs are recognized on a straight-line basis from the grant date to the end of the performance period, which is generally three years, regardless of whether the target relative total shareholder return is achieved. The Monte Carlo simulation model utilizes multiple input variables that determine the probability of satisfying the performance conditions stipulated in the grant agreement in a large number of simulated scenarios. Key assumptions for the Monte Carlo simulation model include risk-free interest rate and expected stock price volatility of both the Company’s common shares and the Russell 2000 index. For hybrid PSUs, share-based compensation expenses are recognized ratably over the vesting period based on the fair value of the hybrid PSUs as of the grant date and the number of shares that are deemed probable of vesting at the end of the specified performance period. The fair value of hybrid PSUs is determined using the Monte-Carlo simulation valuation model as of the date of grant. The probability assessment is performed quarterly and the cumulative effect of a change in the estimated compensation expense, if any, is recognized in the consolidated statement of operations in the period in which such determination is made. Accordingly, share-based compensation expenses associated with hybrid PSUs may differ significantly from period to period based on changes to both the probability and the level of achievement against the specified performance targets. Valuation of Long-lived Assets. The purchase price we pay for acquired companies is allocated first to the identifiable assets acquired and liabilities assumed at their estimated fair value. Any excess purchase price is then allocated to goodwill. We make various assumptions and estimates in order to assign fair value to acquired tangible and intangible assets and liabilities. Key assumptions used to value identifiable intangible assets typically include revenue growth rates and projected cash flows, discount rates, royalty rates, technology obsolescence curves, and customer attrition rates, among others. Actual cash flows may vary from forecasts used to value these assets at the time of the business combination. The estimated fair value of real estate assets acquired in a business combination is estimated based on comparable sales information and other market data, if available, as well as using an income or cost approach, specifically the direct capitalization and replacement value approaches. The direct capitalization and replacement value approaches use key assumptions such as market rent estimates, capitalization rates, local multipliers and remaining useful life of the real estate assets. Assumptions used are subject to management judgment and changes in those assumptions could impact the estimation of the fair value. 47 Our most significant identifiable intangible assets are customer relationships, acquired technologies, trademarks and trade names. In addition to our review of the carrying value of each asset, the estimated useful life assumptions for identifiable intangible assets, including the classification of certain intangible assets as “indefinite-lived,” are reviewed on a periodic basis to determine if changes in circumstances warrant revisions to them. All definite-lived intangible assets are amortized over the periods in which their economic benefits are expected to be realized. Impairment analyses of goodwill and indefinite-lived intangible assets are conducted in accordance with ASC 350, “Intangibles—Goodwill and Other.” We test our goodwill balances annually as of the beginning of the second quarter or more frequently if indicators are present, or changes in circumstances suggest, that an impairment may exist. Should the fair value of our goodwill or indefinite-lived intangible assets decline because of reduced operating performance, market declines or other indicators of impairment, or as a result of changes in the discount rate, charges for impairment loss may be necessary. We evaluate our goodwill, intangible assets and other long-lived assets for impairment at the reporting unit level which is generally at least one level below our reportable segments. We have the option of first performing a qualitative assessment to determine whether it is necessary to perform the quantitative impairment test. In performing the qualitative assessment, we review factors both specific to the reporting unit and to the Company as a whole, such as financial performance, macroeconomic conditions, industry and market considerations, and the fair value of each reporting unit as of the last valuation date. If we elect this option and believe, as a result of the qualitative assessment, that it is more likely than not that the carrying value of goodwill is not recoverable, the quantitative impairment test is required; otherwise, no further testing is performed. Alternatively, we may elect to bypass the qualitative assessment and perform the quantitative impairment test instead. This approach requires a comparison of the carrying value of each of our reporting units to the fair value of these reporting units. If the carrying value of a reporting unit exceeds its fair value, an impairment charge is recorded for the difference. The fair value of a reporting unit is estimated primarily using a discounted cash flow (“DCF”) method. The DCF method requires that we forecast future cash flows for each of the reporting units and discount the cash flow streams based on a weighted average cost of capital (“WACC”) that is derived, in part, from comparable companies within similar industries. The DCF calculations also include a terminal value calculation that is based upon an expected long-term growth rate for the applicable reporting unit. The carrying values of each reporting unit include assets and liabilities which relate to the reporting unit’s operations. Additionally, reporting units that benefit from corporate assets or liabilities are allocated a portion of those corporate assets and liabilities on a proportional basis. We assess indefinite-lived intangible assets for impairment on an annual basis, and more frequently if impairment indicators are identified. We also periodically reassess their continuing classification as indefinite-lived intangible assets. Impairment exists if the fair value of the intangible asset is less than its carrying value. An impairment charge equal to the difference is recorded to reduce the carrying value to its fair value. We evaluate amortizable intangible assets and other long-lived assets for impairment in accordance with ASC 360-10-35-15, “Impairment or Disposal of Long-Lived Assets,” whenever changes in events or circumstances indicate that the carrying values of the reporting units may exceed the undiscounted cash flow forecasts attributable to the reporting units. If undiscounted cash flow forecasts indicate that the carrying value of definite-lived intangible assets or other long-lived assets may not be recoverable, a fair value assessment is performed. For intangible assets, fair value estimates are derived from discounted cash flow forecasts. For other long-lived assets (primarily property, plant and equipment), fair value estimates are derived from the sources most appropriate for the particular asset and have historically included such approaches as sales comparison approach and replacement cost approach. If fair value is less than carrying value, an impairment charge equal to the difference is recorded. We also review the useful life and residual value assumptions for definite-lived intangible assets and other long-lived assets on a periodic basis to determine if changes in circumstances warrant revisions to them. Factors which may trigger an impairment of our goodwill, intangible assets and other long-lived assets include the following: • significant underperformance relative to historical or projected future operating results; • changes in our use of the acquired assets or the strategy for our overall business; • long-term negative industry or economic trends; • technological changes or developments; • changes in competition; • loss of key customers or personnel; • adverse judicial or legislative outcomes or political developments; 48 • significant declines in our stock price for a sustained period of time; and • the decline of our market capitalization below net book value as of the end of any reporting period. The occurrence of any of these events or any other unforeseeable events or circumstances that materially affect future operating results or cash flows may cause an impairment that is material to our results of operations or financial position in the reporting period in which it occurs or is identified. The most recent annual goodwill and indefinite-lived intangible asset impairment test was performed as of the beginning of the second quarter of 2023, using a quantitative assessment, noting no impairment. As of December 31, 2023, there were no indicators of impairment of our long-lived assets. Accounting for Income Taxes. As part of the process of preparing our consolidated financial statements, we are required to calculate our income tax provision (benefit) in each of the jurisdictions in which we operate. This process involves estimating our current income tax provision (benefit) together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are reported on our consolidated balance sheet. Judgment is required in determining our worldwide income tax provision. In the ordinary course of a global business, there are many transactions and calculations where the ultimate outcome is uncertain. Although we believe our estimates are reasonable, there is no assurance that the final outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. Such differences could have a material impact on our income tax provision and net income in the period in which such determination is made. We record a valuation allowance on our deferred tax assets when it is more likely than not that they will not be realized. We have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. In the event we determine that we are able to realize our deferred tax assets in the future in excess of their net recorded amounts, an adjustment to the valuation allowance for the deferred tax assets would be recorded and would increase our net income in the period in which such determination is made. Likewise, should we determine that we will not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the valuation allowance for the deferred tax assets will be recorded and will reduce our net income in the period in which such determination is made. In conjunction with our ongoing review of our actual results and anticipated future earnings, we continuously reassess the adequacy of the valuation allowance currently in place on our deferred tax assets. In 2023, we established a valuation allowance of $2.1 million recorded on net operating losses, various credits, and other timing items in certain tax jurisdictions. The factors used to assess the likelihood of realization of deferred tax assets are the forecast of future taxable income, available tax planning strategies that could be implemented to realize the net deferred tax assets, potential for carryback and future reversals of deferred tax liabilities. The amount of income taxes we pay is subject to audits by federal, state and foreign tax authorities, which may result in proposed assessments. We believe that we have adequately provided for any reasonably foreseeable outcome related to these matters. However, our future results may include favorable or unfavorable adjustments to our tax liabilities in the period that the assessments are made or resolved, or when the statute of limitations for certain periods expires. As of December 31, 2023, the Company’s total amount of unrecognized tax benefits was $4.3 million, of which $3.8 million would favorably affect our effective tax rate, if recognized. Over the next twelve months, we may need to recognize up to $0.3 million of previously unrecognized tax benefits due to statute of limitations closures. Income and foreign withholding taxes have not been recognized on the excess of the amount for financial reporting purposes over the tax basis of investments in foreign subsidiaries that are essentially permanent in nature. This amount becomes taxable upon a repatriation of assets from a subsidiary or a sale or liquidation of a subsidiary. The amount of undistributed earnings of foreign subsidiaries totaled $405.8 million as of December 31, 2023. The estimated unrecognized income and foreign withholding tax liabilities on these undistributed earnings is approximately $5.5 million. Loss Contingencies. We are subject to legal proceedings, lawsuits and other claims relating to product quality, labor, service and other matters arising in the ordinary course of business. We review the status of each significant matter and assess our potential financial exposure on a quarterly basis. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of uncertainties related to these matters, accruals are based only on the best information available as of the date of the financial statements. As additional information becomes available, we will reassess the potential liability related to our pending claims and litigation and may revise our estimates. Such revisions in the estimates of the potential liabilities could have a material impact on our results of operations and financial position. We expense legal fees as incurred. 49 Recent Accounting Pronouncements See Note 2 to Consolidated Financial Statements for recent accounting pronouncements that could have a significant effect on us.