WEST PHARMACEUTICAL SERVICES INC (WST) FY 2022 MD&A

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

OVERVIEW

The following discussion is intended to further the reader’s understanding of the consolidated financial condition and results of operations of the Company. It should be read in conjunction with our consolidated financial statements and the accompanying footnotes included in Part II, Item 8 of this Form 10-K. These historical financial statements may not be indicative of our future performance. This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risks discussed in Part I, Item 1A of this Form 10-K.

Non-U.S. GAAP Financial Measures

For the purpose of aiding the comparison of our year-over-year results, we may refer to net sales and other financial results excluding the effects of changes in foreign currency exchange rates. Organic net sales exclude the impact from acquisitions and/or divestitures and translate the current-period reported sales of subsidiaries whose functional currency is other than USD at the applicable foreign exchange rates in effect during the comparable prior-year period. We may also refer to adjusted consolidated operating profit and adjusted consolidated operating profit margin, which exclude the effects of unallocated items. The unallocated items are not representative of ongoing operations, and generally include restructuring and related charges, certain asset impairments, and other specifically-identified income or expense items. The re-measured results excluding effects from currency translation, the impact from acquisitions and/or divestitures, and excluding the effects of unallocated items are not in conformity with U.S. Generally Accepted Accounting Principles ("GAAP") and should not be used as a substitute for the comparable U.S. GAAP financial measures. The non-U.S. GAAP financial measures are incorporated in our discussion and analysis as management uses them in evaluating our results of operations and believes that this information provides users with a valuable insight into our overall performance and financial position.

Our Operations

We are a leading global manufacturer in the design and production of technologically advanced, high-quality, integrated containment and delivery systems for injectable drugs and healthcare products. Our products include a variety of primary proprietary packaging, containment solutions, reconstitution and transfer systems, and drug delivery systems, as well as contract manufacturing, analytical lab services and integrated solutions. Our customers include leading biologic, generic, pharmaceutical, diagnostic, and medical device companies around the world. Our top priority is delivering quality products that meet the exact product specifications and quality standards customers require and expect. This focus on quality includes a commitment to excellence in manufacturing, scientific and technical expertise and management, which enables us to partner with our customers in order to deliver safe, effective drug products to patients quickly and efficiently.

Our business operations are organized into two global segments, Proprietary Products and Contract-Manufactured Products. Our Proprietary Products reportable segment offers proprietary packaging, containment solutions and drug delivery systems, along with analytical lab services and other integrated services and solutions, primarily to biologic, generic and pharmaceutical drug customers. Our Contract-Manufactured Products reportable segment serves as a fully integrated business, focused on the design, manufacture, and automated assembly of complex devices, primarily for pharmaceutical, diagnostic, and medical device customers. We also maintain collaborations to share technologies and market products with affiliates in Japan and Mexico.

Impact of COVID-19 and other Macroeconomic Factors

West has been actively monitoring the impact of the COVID-19 pandemic globally. Our primary objectives have remained the same throughout the pandemic: to support the safety of our team members and their families and continue to support patients around the world. Our production facilities continue to operate as they had prior to the COVID-19 pandemic, other than for enhanced safety measures intended to prevent the spread of the virus and higher levels of production at certain plant locations to meet additional customer demand.

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Our capital and financial resources, including overall liquidity, remain strong. We will continue to closely monitor the COVID-19 pandemic in order to ensure the safety of our people and our ability to serve our customers and patients worldwide.

Through the twelve months ended December 31, 2022, the war between Russia and Ukraine has not had a material impact on the Company’s business, financial condition or results of operations as we do not have manufacturing operations or significant commercial relationships in either country. However, the continuation of the Russia-Ukraine military conflict and/or an escalation of the conflict beyond its current scope may further weaken the global economy and could result in additional inflationary pressures and supply chain constraints, including the unavailability and cost of energy.

During 2022, we experienced higher costs for raw materials and supply chain challenges related to manufacturing equipment. Due to the uncertainty that exists relative to the duration and overall impact of the macroeconomic factors discussed above, our future operating performance, particularly in the short-term, may be subject to volatility. The impacts of macroeconomic conditions on our business, results of operations, financial condition and cash flows are dependent on certain factors, including those discussed in Item 1A. Risk Factors.

Components of and Key Factors Influencing Our Results of Operations

In assessing the performance of our business, we consider a variety of performance and financial measures. We believe the items discussed below provide insight into the factors that affect these key measures.

Net Sales

Our net sales results from the sale of goods or services and reflects the net consideration which we expect to receive in exchange for those goods or services.

Several factors affect our reported net sales in any period, including product, payer and geographic sales mix, operational effectiveness, pricing realization, timing of orders and shipments, regulatory actions, competition, and business acquisitions that involve our customers or competitors.

Cost of goods and services sold and gross profit

Cost of goods and services sold includes personnel costs, manufacturing costs, raw materials and product costs, freight costs, depreciation, and facility costs associated with our manufacturing and warehouse facilities. Fluctuations in our cost of goods sold correspond with the fluctuations in sales units as well as inflationary and other market factors that influence our cost base.

Gross profit is calculated as net sales less cost of goods and services sold. Our gross profit is affected by product and geographic sales mix, realized pricing of our products, the efficiency of our manufacturing operations and the costs of materials used to make our products.

Research and development expenses

Research and development expenses relate to our investments in improvements to our manufacturing processes, product enhancements, and additional investments in our elastomeric packaging components, formulation development, drug containment systems, self-injection systems and drug administration consumables.

We expense research and development costs as incurred. Our research and development expenses fluctuate from period to period primarily based on the ongoing improvements to our manufacturing processes and product enhancements.

Selling, general and administrative expenses

Selling, general and administrative expenses primarily include personnel costs, incentive compensation, insurance, professional fees, and depreciation.

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Financial Performance Summary

The following tables present a reconciliation from U.S. GAAP to non-U.S. GAAP financial measures:

During 2022, we recorded a tax benefit of $16.5 million associated with stock-based compensation.

During 2021, we recorded a tax benefit of $31.5 million associated with stock-based compensation.

During 2020, we recorded a tax benefit of $20.8 million associated with stock-based compensation.

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(1) During 2022, the Company recorded restructuring and related charges of $23.8 million, which primarily included $8.7 million in net severance and post-employment benefits primarily in connection with our plan to adjust our operating cost base and $15.3 million in asset-related charges associated with this plan. During 2021 and 2020, the Company recorded a restructuring and severance related charge of $2.2 million and $7.0 million, respectively, to optimize certain organizational structure within the Company. Please refer to Note 16, Other Expense (Income), for further discussion of these items.

(2) During 2022, we recorded a gross pension settlement charge of $52.2 million within other nonoperating expense (income), which primarily relates to the full settlement of the U.S. qualified defined benefit plan (the "U.S. pension plan"). In 2021 and 2020, we recorded a pension settlement charge each year within other nonoperating expense (income), as it was determined that normal-course lump-sum payments for our U.S. pension plan exceeded the threshold for settlement accounting. Please refer to Note 15, Benefit Plans, for further discussion of these items.

(3) During 2022, the Company recorded $0.7 million of amortization expense within operating profit associated with an acquisition of an intangible asset during the second quarter of 2020. Additionally, the company recorded $2.1 million of amortization expense in association with an acquisition of increased ownership interest in Daikyo. During 2021, the Company recorded $0.8 million of amortization expense within operating profit associated with an acquisition of an intangible asset during the second quarter of 2020. Additionally, the company recorded $2.1 million of amortization expense in association with an acquisition of increased ownership interest in Daikyo. During 2020, the company recorded $0.6 million of amortization expense within operating profit associated with an acquisition of an intangible asset during the second quarter of 2020. Additionally, the company recorded $3.1 million of amortization expense in association with an acquisition of increased ownership interest in Daikyo.

(4) During 2021, the Company recorded a $2.8 million impairment charge for certain long-lived and intangible assets within the Proprietary Products segment as it determined the carrying value exceeded the fair value of the assets. $1.9 million of this charge is recorded in Cost of Goods and Services Sold and $0.9 million of the charge is recorded in Selling, General, and Administrative expense, due to the nature of the impaired assets.

(5) During 2022, the Company recorded a cost investment impairment charge of $3.5 million. During 2021, the net cost investment activity was $4.3 million, inclusive of an impairment charge of $4.6 million offset by a $0.3 million gain on the sale of a cost investment. During 2020, the Company recorded a cost investment impairment charge of $2.5 million.

(6) During 2022, the Company increased its expected tax benefit related to the prepayment of future royalties from one of its subsidiaries by $1.3 million. During 2021, the Company prepaid future royalties from one of its subsidiaries, which resulted in a $18.5 million tax benefit.

(7) During 2022, the Company incurred additional tax expense of $5.7 million due to the impact of a tax law change in the state of Pennsylvania enacted during the period. During 2021, the Company recorded a tax benefit of $1.4 million due to the impact of a United Kingdom tax law change enacted during the period.

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RESULTS OF OPERATIONS

We evaluate the performance of our segments based upon, among other things, segment net sales and operating profit. Segment operating profit excludes general corporate costs, which include executive and director compensation, stock-based compensation, certain pension and other retirement benefit costs, and other corporate facilities and administrative expenses not allocated to the segments. Also excluded are items that we consider not representative of ongoing operations. Such items are referred to as other unallocated items for which further information can be found above in the reconciliation from U.S. GAAP to non-U.S. GAAP financial measures. Discussion of the year-over-year changes for the fiscal year ended December 31, 2021 compared to the fiscal year ended December 31, 2020 and the results of operations and cash flows for the fiscal year ended December 31, 2020 is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Result of Operations of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the SEC on February 22, 2022, and is incorporated herein by reference.

Percentages in the following tables and throughout this Results of Operations section may reflect rounding adjustments.

Net Sales

The following table presents net sales, consolidated and by reportable segment:

Consolidated net sales increased by $55.3 million, or 2.0%, in 2022, due to sales price increases of approximately $106 million and a favorable mix of products sold despite a decline in net COVID-19 related activity for COVID-19 vaccines and antiviral treatments. This was partially offset by an unfavorable foreign currency translation impact of $162.6 million. Excluding foreign currency translation effects, consolidated net sales increased by $217.9 million, or 7.7%.

Proprietary Products – Proprietary Products net sales increased by $89.5 million, or 3.9%, in 2022, including an unfavorable foreign currency translation impact of $138.6 million. Excluding foreign currency translation effects, net sales increased by $228.1 million, or 9.8%. The increase is primarily due to growth in our high-value product offerings of approximately $168 million, including our NovaPure®, Envision® and Westar® products, which is inclusive of sales price increases and an approximately $71 million decline in net COVID-19 related activity for COVID-19 vaccines and antiviral treatments.

Contract-Manufactured Products – Contract-Manufactured Products net sales decreased by $34.3 million, or 6.7%, in 2022, including an unfavorable foreign currency translation impact of $24.0 million. Excluding foreign currency translation effects, net sales decreased by $10.3 million, or 2.0%, due to a decline in sales of components for diagnostic devices, offset by sales price increases.

The intersegment sales elimination, which is required for the presentation of consolidated net sales, represents the elimination of components sold between our segments.

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Gross Profit

The following table presents gross profit and related gross margins, consolidated and by reportable segment and by unallocated:

Consolidated gross profit decreased by $39.6 million, or 3.4%, in 2022, including an unfavorable foreign currency translation impact of $60.4 million. Consolidated gross profit margin decreased by 2.1 margin points in 2022, due to increased plant spend to meet ongoing product demand and increased labor and overhead costs, primarily within transportation and compensation, that were driven by inflation. This was offset by increased sales prices.

Proprietary Products – Proprietary Products gross profit decreased by $40.6 million, or 3.7%, in 2022, including an unfavorable foreign currency translation impact of $55.7 million. Proprietary Products gross profit margin decreased by 3.4 margin points in 2022. The decrease is driven by inflationary headwinds of approximately $85 million, additional plant spend to meet ongoing product demand and a higher allocation of functional spend from Selling, General and Administrative Costs of approximately $18 million, offset by increased sales prices and a favorable mix of products sold.

Contract-Manufactured Products – Contract-Manufactured Products gross profit decreased by $0.9 million, or 1.1%, in 2022, including an unfavorable foreign currency translation impact of $4.7 million. Contract-Manufactured Products gross profit margin increased by 1.0 margin points in 2022, due to increased sales prices and production efficiencies, offset by an unfavorable mix of products sold and additional costs driven by inflation of approximately $16 million.

Research and Development (“R&D”) Costs

The following table presents consolidated R&D costs:

Consolidated R&D costs increased by $5.7 million, or 10.8%, in 2022, as compared to 2021, due to additional research performed to identify new product opportunities, offset by lower annual incentive compensation. Efforts remain focused on the continued investment in elastomeric packaging components, formulation development, drug containment systems, self-injection systems and drug administration consumables.

All of the R&D costs incurred during 2022, 2021 and 2020 related to Proprietary Products.

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Selling, General and Administrative (“SG&A”) Costs

The following table presents SG&A costs, consolidated and by reportable segment and corporate and unallocated items:

Consolidated SG&A costs decreased by $45.9 million, or 12.7%, in 2022, including a favorable foreign currency translation impact of $7.9 million. The decrease was primarily due to lower annual incentive compensation and a higher allocation of functional spend to Cost of Goods and Services Sold, offset by an increase in professional fees and salaries and fringe benefits.

Proprietary Products – Proprietary Products SG&A costs decreased by $32.2 million, or 13.2%, in 2022, primarily due to higher allocation of functional spend to Cost of Goods and Services Sold of approximately $18 million, lower annual incentive compensation of approximately $17 million, and a favorable foreign currency translation impact of $6.6 million.

Contract-Manufactured Products – Contract-Manufactured Products SG&A costs increased by $5.0 million, or 31.4%, in 2022, primarily due to a higher allocation of functional spend and increased salaries and fringe benefits, partially offset by a reduction in annual incentive compensation.

Corporate – Corporate SG&A costs decreased by $18.7 million, or 18.3%, in 2022, primarily due to a reduction in mark-to-market expense related to stock-based compensation of approximately $10 million and lower annual incentive compensation of approximately $7 million.

Other Expense (Income)

The following table presents other expense and income items, consolidated and by reportable segment and corporate and unallocated items:

Other expense and income items consist of foreign exchange transaction gains and losses, gains and losses on the sale of fixed assets, contingent consideration, fixed asset impairments and miscellaneous income and charges.

Consolidated other expense (income) changed by $18.9 million in 2022 as compared to 2021, due to the factors described below, primarily an increase in restructuring and related charges in 2022.

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Proprietary Products – Proprietary Products other expense (income) changed by $2.4 million in 2022 as compared to 2021, primarily due to increased gains on foreign exchange transactions of $3.1 million, offset by increased contingent consideration charges of $1.5 million recorded in 2022 as compared to 2021.

Contract-Manufactured Products – Contract-Manufactured Products other expense (income) changed by $0.9 million in 2022 as compared to 2021, primarily due to increased fixed asset impairments of $0.7 million recorded in 2022 as compared to 2021.

Corporate and unallocated items – Corporate and unallocated items changed by $20.4 million in 2022 as compared to 2021. During 2022, we recorded $23.8 million in restructuring and related charges and $3.5 million in impairment charges related to our cost investments within Corporate and unallocated items. During 2021, we recorded $2.2 million in restructuring and related charges and a total impairment charge of $4.6 million which was offset by a net gain of $0.3 million on the sale of a cost investment, within Corporate and unallocated items.

Operating Profit

The following table presents operating profit and adjusted operating profit, consolidated and by reportable segment, corporate and unallocated items:

Consolidated operating profit decreased by $18.3 million, or 2.4%, in 2022, including an unfavorable foreign currency translation impact of $51.8 million, due to the factors described above.

Proprietary Products – Proprietary Products operating profit decreased by $11.7 million, or 1.5%, in 2022, including an unfavorable foreign currency translation impact of $48.1 million, due to the factors described above.

Contract-Manufactured Products – Contract-Manufactured Products operating profit decreased by $6.8 million, or 10.1%, in 2022, including an unfavorable foreign currency translation impact of $3.7 million, due to the factors described above.

Corporate – Excluding the unallocated items, Corporate costs decreased by $18.1 million, or 17.9%, in 2022, due to the factors described above.

Unallocated items - Please refer to the Financial Performance Summary section above for details.

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Interest Expense, Net

The following table presents interest expense, net, by significant component:

Interest expense, net, decreased by $0.3 million, or 3.7%, in 2022, primarily due to an increase in capitalized interest driven by higher capital expenditures in 2022, as compared to 2021.

Interest income increased by $4.1 million in 2022, resulting from higher interest rates compared to the prior year.

Other Nonoperating Expense (Income)

Other nonoperating expense (income) changed by $55.1 million in 2022, primarily due to the recording of a $52.2 million pension settlement charge in 2022, which relieved the historical balance sheet position, inclusive of accumulated other comprehensive income, of the U.S. pension plan.

Income Taxes

The provision for income taxes was $114.7 million, $107.2 million, and $72.5 million for the years 2022, 2021, and 2020, respectively, and the effective tax rate was 16.9%, 14.3%, and 18.1%, respectively.

The increase in the effective tax rate in 2022 of 2.6%, or $7.5 million of additional tax expense, is due to the Company's recognition of reserves for unrecognized tax benefits of $19.8 million in 2022, the prepayment of future royalties from one of its subsidiaries in 2021, which resulted in a $18.5 million tax benefit in 2021, as well as a $15.0 million reduction in our tax benefit related to stock-based compensation compared to 2021. This was offset by the tax benefit of $20.6 million recognized for the 2022 termination of our U.S. pension plan as well as a favorable geographic mix of our earnings in jurisdictions with a lower tax rate.

Please refer to Note 17, Income Taxes, for further discussion of our income taxes.

Equity in Net Income of Affiliated Companies

Equity in net income of affiliated companies was $20.7 million, $20.1 million, and $17.4 million for the years 2022, 2021, and 2020, respectively. Equity in net income of affiliated companies increased by $0.6 million, or 3.0%, in 2022, primarily due to favorable operating results at Daikyo and the Mexico affiliates, offset by the impact of foreign currency translation.

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FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Cash Flows

The following table presents cash flow data for the years ended December 31:

Net Cash Provided by Operating Activities

Net cash provided by operating activities increased by $140.0 million in 2022, primarily due to a year over year improvement in working capital management primarily within accounts receivable and inventory, partially offset by a decrease in net income.

Net Cash Used in Investing Activities

Net cash used in investing activities increased by $35.1 million in 2022, primarily due to increases in capital expenditures for additional manufacturing capacity in 2022 to meet customer demand.

Net Cash Used in Financing Activities

Net cash used in financing activities increased by $125.5 million in 2022, primarily due to increases in purchases under our share repurchase program in 2022 and additional debt repayments in 2022 according to the maturity date.

Liquidity and Capital Resources

The table below presents selected liquidity and capital measures as of:

Cash and cash equivalents include all instruments that have maturities of ninety days or less when purchased. Working capital is defined as current assets less current liabilities.

Cash and cash equivalents – Our cash and cash equivalents balance at December 31, 2022 consisted of cash held in depository accounts with banks around the world and cash invested in high-quality, short-term investments. The cash and cash equivalents balance at December 31, 2022 included $317.8 million of cash held by subsidiaries within the U.S. and $576.5 million of cash held by subsidiaries outside of the U.S. For further information on our position regarding permanent reinvestment of foreign subsidiary earnings and profits refer to Note 17, Income Taxes.

Working capital - Working capital at December 31, 2022 increased by $252.6 million, or 22.0%, as compared to December 31, 2021, which includes an unfavorable foreign currency translation impact of $6.9 million. Excluding the impact of currency exchange rates, cash and cash equivalents, accounts receivable, and inventories increased by

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$142.2 million, $35.5 million and $49.7 million, respectively, while total current liabilities decreased by $60.8 million. The increase in cash and cash equivalents was due to cash collections from operations, offset by share repurchases, debt repayments and payment of annual incentive compensation during 2022. The increase in accounts receivable was due to increased sales activity. The increase in inventories that occurred in the period was to ensure we have sufficient inventory on hand to support the needs of our customers. The decrease in total current liabilities was caused by the decline in accrued salaries, wages and benefits and accounts payable.

Debt and credit facilities - The $44.1 million decrease in total debt at December 31, 2022, as compared to December 31, 2021, resulted from our $42.0 million principal repayment of the Series A notes on July 5, 2022 and quarterly repayments of principal under our Term Loan.

Our sources of liquidity include our Credit Facility. At December 31, 2022, we had no outstanding borrowings under the Credit Facility. At December 31, 2022, the borrowing capacity available under the Credit Facility, including outstanding letters of credit of $2.4 million, was $497.6 million. We do not expect any significant limitations on our ability to access this source of funds. Please refer to Note 10, Debt, for further discussion of our Credit Facility.

Pursuant to the financial covenants in our debt agreements, we are required to maintain established interest coverage ratios and to not exceed established leverage ratios. In addition, the agreements contain other customary covenants, none of which we consider restrictive to our operations. At December 31, 2022, we were in compliance with all of our debt covenants, and we expect to continue to be in compliance with the terms of these agreements throughout 2023.

We believe that cash on hand and cash generated from operations, together with availability under our Credit Facility, will be adequate to address our foreseeable liquidity needs based on our current expectations of our business operations, capital expenditures and scheduled payments of debt obligations to continue to meet customer demand.

Commitments and Contractual Obligations

Contractual obligations associated with ongoing business activities are expected to result in cash payments in future periods, and include the following material items:

•Our business creates a need to enter into various commitments with suppliers, including for the purchase of raw materials and finished goods. In accordance with U.S. GAAP, these purchase obligations are not reflected in the accompanying consolidated balance sheets. At December 31, 2022, our outstanding unconditional contractual commitments, including for the purchase of raw materials and finished goods, amounted to $96.8 million, of which $70.9 million is due to be paid in 2023. These purchase commitments do not exceed our projected requirements and are in the normal course of business. The Company previously entered into a material supply agreement for butyl polymers used as a principal raw material in a broad range of the Company’s polymer-based pharmaceutical packaging products.

•Our long-term debt obligations, net of unamortized debt issuance costs including fixed and variable-rate debt, is further discussed in Note 10, Debt.

•Our operating lease obligations primarily related to land, buildings, and machinery and equipment, with lease terms through 2047 further discussed in Note 6, Leases.

CRITICAL ACCOUNTING ESTIMATES

Management’s discussion and analysis addresses consolidated financial statements that are prepared in accordance with U.S. GAAP. The application of these principles requires management to make estimates and assumptions, some of which are subjective and complex, that affect the amounts reported in the consolidated financial statements. We believe the following accounting policies and estimates are critical to understanding and evaluating our results of operations and financial position:

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Impairment of Long-Lived Assets: Long-lived assets, including property, plant and equipment and operating lease right-of-use assets, are tested for impairment whenever circumstances, such as a deterioration in general macroeconomic conditions or a change in company strategy, increased competition, declining product demand, plans to dispose of an asset or asset group, or recent financial or legal factors that could impact the expected cash flows, indicate that the carrying value of these assets may not be recoverable. An asset is considered impaired if the carrying value of the asset exceeds the sum of the future expected undiscounted cash flows to be derived from the asset. Impairment reviews are based on an estimated future cash flow approach that requires significant judgment with respect to future revenue and expense growth rates, selection of appropriate discount rate, asset groupings, and other assumptions and estimates. The Company uses estimates that are consistent with its business plans and a market participant view of the assets being evaluated. Once an asset is considered impaired, an impairment loss is recorded within other expense (income) for the difference between the asset’s carrying value and its fair value. For assets held and used in the business, management determines fair value using estimated future cash flows to be derived from the asset, discounted to a net present value using an appropriate discount rate. For assets held for sale or for investment purposes, management determines fair value by estimating the proceeds to be received upon sale of the asset, less disposition costs.

Impairment of Goodwill and Other Intangible Assets: Goodwill is tested for impairment at least annually, following the completion of our annual budget and long-range planning process, or whenever circumstances indicate that the carrying value of these assets may not be recoverable. Goodwill is tested for impairment at the reporting unit level, which is the same as, or one level below, our operating segments. A goodwill impairment charge represents the amount by which a reporting unit’s carrying amount exceeds its fair value, not to exceed the total amount of goodwill allocated to that reporting unit. Considerable management judgment is necessary to estimate fair value. Amounts and assumptions used in our goodwill impairment test, such as future sales, future cash flows and long-term growth rates, are consistent with internal projections and operating plans. Amounts and assumptions used in our goodwill impairment test are also largely dependent on the continued sale of drug products delivered by injection and the packaging of drug products, as well as our timeliness and success in new-product innovation or the development and commercialization of proprietary multi-component systems. Changes in the estimate of fair value, including the estimate of future cash flows, could have a material impact on our future results of operations and financial position. Accounting guidance also allows entities to first assess qualitative factors, including macroeconomic conditions, industry and market considerations, cost factors, and overall financial performance, to determine whether it is necessary to perform the quantitative goodwill impairment test. We elected to follow this guidance for our annual impairment test. If, based upon our assessment, we determined that it was not more likely than not that the fair value of each of our reporting units was less than its carrying amount, then it would not be necessary to perform the quantitative goodwill impairment test.

Valuing identifiable intangible assets requires judgment. For example, for recent identifiable customer relationship intangible asset acquisitions, we applied an excess earnings model, which is a form of the income approach. This approach includes projecting revenues and expenses attributable to the existing customers over the remaining economic life of the customer relationships and then subtracting the required return on net tangible assets and any intangible assets used in the business to estimate any residual excess earnings attributable to the customer relationships. The after-tax excess earnings are then discounted to present value using the respective discount rates. Intangible assets with finite lives are amortized using the straight-line method over their estimated useful lives, and reviewed for impairment whenever circumstances indicate that the carrying value of these assets may not be recoverable. Factors that could trigger an impairment review include the following: 1) significant under-performance relative to historical or projected future operating results; 2) significant changes in the manner of use of the acquired assets or the strategy of the overall business; 3) significant negative industry or economic trends; and 4) recognition of goodwill impairment charges. If we determine that the carrying value of identifiable intangibles may not be recoverable based on the existence of one or more of the above indicators of impairment, we measure recoverability of assets by comparing the respective carrying value of the assets to the current and expected future cash flows, on an un-discounted basis, to be generated from such assets. If such analysis indicates that the carrying value of these assets is not recoverable, we measure an impairment based on the amount in which the net carrying amount of the assets exceeds the fair values of the assets.

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Employee Benefits: We maintain funded and unfunded defined benefit pension plans in the U.S. and a number of other countries that cover employees who meet eligibility requirements. In addition, we sponsor postretirement benefit plans which provide healthcare benefits for eligible employees who retire or become disabled. Postretirement benefit plans are limited to only those active employees who met the eligibility requirements as of January 1, 2017. The measurement of annual cost and obligations under these defined benefit pension and postretirement plans are subject to a number of assumptions, which are specific for each of our U.S. and foreign plans. The assumptions, which are reviewed at least annually, are relevant to both the plan assets (where applicable) and the obligation for benefits that will ultimately be provided to our employees. Two of the most critical assumptions in determining pension expense are the discount rate and expected long-term rate of return on plan assets. Other assumptions reflect demographic factors such as retirement age, rates of compensation increases, mortality and turnover, and are evaluated periodically and updated to reflect our actual experience. For our funded plans, we consider the current and expected asset allocations of our plan assets, as well as historical and expected rates of return, in estimating the long-term rate of return on plan assets. One of the most critical assumptions in determining retiree mental plan expense is the discount rate. Under U.S. GAAP, differences between actual and expected results are generally accumulated in other comprehensive income (loss) as actuarial gains or losses and subsequently amortized into earnings over future periods.

Changes in key assumptions could have a material impact on our future results of operations and financial position. We estimate that every 25-basis point reduction in our long-term rate of return assumption would increase pension expense by $0.1 million, and every 25-basis point reduction in our discount rate would decrease pension expense by $0.0 million. A decrease in the discount rate increases the present value of benefit obligations. Our net pension underfunded balance at December 31, 2022 was $26.1 million, compared to $20.6 million at December 31, 2021. Our underfunded balance for other postretirement benefits was $3.9 million at December 31, 2022, compared to $5.6 million at December 31, 2021.

Income Taxes: We estimate income taxes payable based upon current domestic and international tax legislation. In addition, deferred income taxes are recognized by applying enacted statutory tax rates to tax loss carryforwards and temporary differences between the tax basis and financial statement carrying values of our assets and liabilities. The enacted statutory tax rate applied is based on the rate expected to be applicable at the time of the forecasted utilization of the loss carryforward or reversal of the temporary difference. Valuation allowances on deferred tax assets are established when it is more likely than not that all or a portion of a deferred tax asset will not be realized. The realizability of deferred tax assets is subject to our estimates of future taxable income, generally at the respective subsidiary company and country level. Changes in tax legislation, business plans and other factors may affect the ultimate recoverability of tax assets or final tax payments, which could result in adjustments to tax expense in the period such change is determined.

When accounting for uncertainty in income taxes recognized in our financial statements, we apply a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.

Please refer to Note 1, Basis of Presentation and Summary of Significant Accounting Policies to our consolidated financial statements for additional information on our significant accounting policies.

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