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 1 of this Quarterly Report on
Form 10-Q. 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 the anticipated
impacts of the COVID-19 pandemic on our business, our financial results and our
financial condition; our belief that the Purchasing Managers Index ("PMI") 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
constraints; 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; integration and anticipated
benefits from acquisitions and dispositions; anticipated economic benefits,
costs and timelines of restructuring programs; ability to repay our
indebtedness; our intentions regarding the use of cash; expectations regarding
legal and regulatory 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, but not limited to, the
following: economic and political conditions and the effects of these conditions
on our customers' businesses, capital expenditures and level of business
activities; risks associated with the COVID-19 pandemic and other events outside
of our control; our dependence upon our ability to respond to fluctuations in
product demand; our ability to continually innovate, introduce new products
timely, and successfully commercialize our innovations; customer order timing
and other similar factors beyond our control; disruptions or breaches in
security of our and our third-party providers' information technology systems;
our failure to comply with data privacy regulations; changes in interest rates,
credit ratings or foreign currency exchange rates; risks associated with our
operations in foreign countries; our increased use of outsourcing in foreign
countries; risks associated with increased outsourcing of components
manufacturing; our exposure to increased tariffs, trade restrictions or taxes on
our products; negative effects on global economic conditions, financial markets
and our business as a result of the United Kingdom's withdrawal from the
European Union; violations of our intellectual property rights and our ability
to protect our intellectual property against infringement by third parties; risk
of losing our competitive advantage; our failure to successfully integrate
recent and future acquisitions into our business; our ability to attract and
retain key personnel; our restructuring and realignment activities and
disruptions to our operations as a result of consolidation of our operations;
product defects or problems integrating our products with other vendors'
products; disruptions in the supply of certain key components or other goods
from our suppliers; our failure to accurately forecast component and raw
material requirements leading to excess inventories or delays in the delivery of
our products; production difficulties and product delivery delays or
disruptions; our exposure to medical device regulations, which may impede or
hinder the approval or sale of our products and, in some cases, may ultimately
result in an inability to obtain approval of certain products or may result in
the recall or seizure of previously approved products; potential penalties for
violating foreign and U.S. federal and state healthcare laws and regulations;
impact of healthcare industry cost containment and healthcare reform measures;
changes in governmental regulations affecting our business or products; our
failure to implement new information technology systems and software
successfully; our failure to realize the full value of our intangible assets;
increasing scrutiny and changing expectations from investors, customers, and
governments with respect to Environmental, Social and Governance policies and
practices; our exposure to the credit risk of some of our customers and in
weakened markets; our reliance on third party distribution channels; our
reliance on original equipment manufacturer customers; being subject to U.S.
federal income taxation even though we are a non-U.S. corporation; changes in
tax laws and fluctuations in our effective tax rates; any need for additional
capital to adequately respond to business challenges or opportunities and repay
or refinance our existing indebtedness, which may not be available on acceptable
terms or at all; our existing indebtedness limiting our ability to engage in
certain activities; volatility in the market price for our common shares; and
our failure to maintain appropriate internal controls in the future. Other
important risk factors that could affect the outcome of the events set forth in
these statements and that could affect the Company's operating results and
financial condition are discussed in Item 1A of our Annual Report on Form 10-K
for the fiscal year ended December 31, 2021 under the heading "Risk Factors", as
updated in our other filings with the Securities and Exchange Commission. In
this Quarterly Report on Form 10-Q, the words "expects," "intends,"
"anticipates," "estimates," "believes," "future," "plans," "aims," "would,"
"could," "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 forward-looking statements to reflect any
changes 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.
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Accounting Period
The interim consolidated financial statements of Novanta Inc. and its
subsidiaries (collectively referred to as the "Company", "Novanta", "we", "us",
"our") are prepared for each quarterly period ending on the Friday closest to
the end of the calendar quarter, except for the fourth quarter which always ends
on December 31.
Business Overview
We are 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
photonics, vision and precision motion 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.
Reportable Segments
We operate in three reportable segments: Photonics, Vision, and Precision
Motion. The reportable segments and their principal activities are summarized
below.
Photonics
Our Photonics segment designs, manufactures and markets photonics-based
solutions, including laser scanning, laser beam delivery, CO2 laser, solid state
laser, ultrafast laser, and optical light engine products, to customers
worldwide. The segment serves highly demanding photonics-based applications for
advanced industrial processes, metrology, medical and life science imaging, DNA
sequencing, and medical laser procedures, particularly ophthalmology
applications. The vast majority of the segment's product offerings are sold to
OEM customers. The segment sells these products both directly, utilizing a
highly technical sales force, and indirectly, through resellers and
distributors.
Vision
Our Vision segment designs, manufactures and markets a range of medical grade
technologies, including medical insufflators, pumps and related disposables;
visualization solutions; wireless technologies, video recorder and video
integration technologies for operating room integrations; optical data
collection and machine vision technologies; radio frequency identification
("RFID") technologies; thermal chart recorders; spectrometry technologies; and
embedded touch screen solutions. The vast majority of the segment's product
offerings are sold to OEM customers. The segment sells these products both
directly, utilizing a highly technical sales force, and indirectly, through
resellers and distributors.
Precision Motion
Our Precision Motion segment designs, manufactures and markets optical and
inductive encoders, precision motors, servo drives and motion control solutions,
integrated stepper motors, intelligent robotic end-of-arm technology solutions,
air bearings, and air bearing spindles to customers worldwide. The vast majority
of the segment's product offerings are sold to OEM customers. The segment sells
these products both directly, utilizing a highly technical sales force, and
indirectly, through resellers and distributors.
End Markets
We primarily operate in two end markets: the medical market and the advanced
industrial market.
Medical Market
For the six months ended July 1, 2022, the medical market accounted for
approximately 47% 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.
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Advanced Industrial Market
For the six months ended July 1, 2022, the advanced industrial market accounted
for approximately 53% of our revenue. Revenue from our products sold to the
advanced industrial market is affected by several factors, including changing
technology requirements and preferences of our customers, productivity or
quality investments in a manufacturing environment, financial conditions of our
customers, changes in regulatory requirements and laws, and general economic
conditions. We believe that the Purchasing Managers Index (PMI) 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.
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
components and sub-systems 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 and motivated
employees.
Significant Events and Updates
Amendment to Third Amended and Restated Credit Agreement
On March 10, 2022, we entered into an amendment (the "Fifth Amendment") to the
third amended and restated credit agreement, dated as of December 31, 2019 (as
amended, the "Credit Agreement"). The Fifth Amendment amends the 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 option from
$200 million to $350 million.
Impact of COVID-19 on Our Business
In response to the COVID-19 pandemic, we have taken proactive, aggressive
actions to protect the health and safety of our employees. We established
steering committees at both the corporate level and at each of our major
facilities to provide leadership for and manage our COVID-19 risk mitigation
actions and countermeasures. We established rigorous safety measures in all of
our facilities and have adapted our COVID-19 safety measures as the pandemic and
related government mandates evolved over the past
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two years. We expect to continue some of these measures until we determine that
the COVID-19 pandemic is adequately contained for purposes of our business. We
may take further actions as government authorities require or recommend or as we
determine to be in the best interest of our employees. In connection with our
COVID-19 remediation actions, we have incurred additional costs to protect the
health of our employees, including investments in technologies and monitoring
equipment, weekly testing of unvaccinated employees for COVID-19 at certain
locations and rearranging some of our facilities to accommodate social
distancing and flexible post-pandemic work environment.
Infection rates and the corresponding public health restrictions vary across the
countries in which we operate. Many governmental authorities have continued to
implement numerous evolving measures to try to contain the virus, such as travel
bans and restrictions, masking recommendations and mandates, vaccine
recommendations and mandates, limitations on gatherings, mandatory quarantines,
shelter-in-place orders, and business shutdowns. While COVID-19 restrictions
have been relaxed in the U.S. and Europe, in response to outbreaks of infection
in various locations within China, governmental authorities have implemented
lockdown orders in some areas, significantly slowing economic and business
activities. Our manufacturing and distribution operations in Suzhou, China have
been impacted to a limited degree by these recent lockdowns. The extent to which
government lockdowns in China or any other country will impact our business and
our financial results will depend on future developments, which are highly
uncertain and cannot be reasonably estimated at this time.
Through July 1, 2022, we have experienced disruptions to our supply chain as a
result of the COVID-19 pandemic and global electronics and other raw material
shortages. While we regularly monitor the manufacturing output of companies in
our supply chain, disruptions to our suppliers and/or sub-suppliers caused by
these events could further challenge our ability to obtain raw materials or
components required to manufacture our products, adversely affecting our
operations and customer relationships.
To mitigate the risk of any potential supply interruptions from the COVID-19
pandemic and the global electronics and other raw material shortages, we are
identifying alternative suppliers and distributors, sourcing raw materials from
different supplier and distributor locations, modifying our product designs
where feasible to allow for alternative components to be used without
compromising quality, performance or other requirements, in-sourcing production
of parts where feasible, and taking other actions to ensure a sustainable supply
of raw materials. Despite our mitigation actions, if certain suppliers cannot
produce a key part or component for us, or if the receipt of certain materials
is otherwise delayed, we may miss our scheduled shipment deadlines and our
relationship with customers may be harmed.
Additionally, restrictions on or disruptions of transportation, such as reduced
availability of air transports, port closures and backlogs, and increased border
controls or closures, have resulted in higher costs and delays, both for
obtaining raw materials from suppliers and for shipping finished products to
customers.
The COVID-19 pandemic and the global electronics and other raw material
shortages have caused inflationary pressures on the market prices for certain of
our parts and primary raw materials as well as increases in the costs of labor,
freight, packaging, energy and other consumables that are used in our
manufacturing processes. We have generally been able to offset increases in
these costs through various productivity and cost reduction initiatives, as well
as adjusting 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.
Russia Ukraine Conflict
In February 2022, Russian forces invaded Ukraine. In response, the United
States, the European Union, 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 United States, the European Union, and several other countries.
Our sales to Russia are not material. We continue to assess the conflict and
related global sanctions and take steps to attempt to mitigate the potential
negative impact on our business. Any longer-term impact to our business is
currently unknown due to the uncertainty around the duration of the conflict,
any further global sanctions and their broader impact on the global economy and
inflation.
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Results of Operations for the Three and Six Months Ended July 1, 2022 Compared
with the Three and Six Months Ended July 2, 2021
The following table sets forth our unaudited results of operations as a
percentage of revenue for the periods indicated:
Three Months Ended Six Months Ended
July 1, July 2, July 1, July 2,
2022 2021 2022 2021
Revenue 100.0 % 100.0 % 100.0 % 100.0 %
Cost of revenue 55.8 56.8 55.8 57.2
Gross profit 44.2 43.2 44.2 42.8
Operating expenses:
Research and development and
engineering 10.0 10.1 10.1 10.8
Selling, general and administrative 18.8 18.6 19.0 19.1
Amortization of purchased intangible
assets 3.3 2.1 3.5 2.2
Restructuring, acquisition, and
related costs 1.2 2.8 0.2 2.5
Total operating expenses 33.4 33.7 32.9 34.6
Operating income 10.8 9.5 11.3 8.2
Interest income (expense), net (1.3 ) (0.8 ) (1.4 ) (0.8 )
Foreign exchange transaction gains
(losses), net 0.1 (0.0 ) 0.1 (0.1 )
Other income (expense), net 0.0 (0.1 ) (0.1 ) (0.1 )
Income before income taxes 9.6 8.6 9.9 7.2
Income tax provision (benefit) 1.5 1.7 1.2 0.3
Consolidated net income 8.1 % 7.0 % 8.7 % 7.0 %
Overview of Financial Results
Total revenue of $215.4 million for the three months ended July 1, 2022
increased $47.8 million, or 28.6%, from the prior year period primarily due to
revenue from prior year acquisitions and increased demand in the advanced
industrial and medical markets. The effect of our prior year acquisitions
resulted in an increase in revenue of $34.9 million, or 20.9%. In addition,
foreign currency exchange rates adversely impacted our revenue by $8.6 million,
or 5.2%, for the three months ended July 1, 2022.
Total revenue of $419.6 million for the six months ended July 1, 2022 increased
$89.5 million, or 27.1%, from the prior year period primarily due to revenue
from prior year acquisitions and increased demand in the advanced industrial and
medical markets. The effect of our prior year acquisitions resulted in an
increase in revenue of $67.8 million, or 20.5%. In addition, foreign currency
exchange rates adversely impacted our revenue by $11.9 million, or 3.6%, for the
six months ended July 1, 2022.
Operating income of $23.3 million for the three months ended July 1, 2022
increased $7.3 million, or 45.6%, from the prior year period. This increase was
attributable to an increase in gross profit of $22.8 million primarily
attributable to higher revenue, an increase in gross profit margin, and a
decrease in restructuring, acquisition, and related charges of $2.0 million,
partially offset by an increase in research and development and engineering
("R&D") expenses of $4.6 million, an increase in selling, general and
administrative ("SG&A") expenses of $9.3 million and an increase in amortization
expense of $3.6 million.
Operating income of $47.6 million for the six months ended July 1, 2022
increased $20.5 million, or 75.6%, from the prior year period. This increase was
attributable to an increase in gross profit of $44.4 million primarily
attributable to higher revenue, an increase in gross profit margin, and a
decrease in restructuring, acquisition, and related charges of $7.3 million,
partially offset by an increase in R&D expenses of $6.9 million, an increase in
SG&A expenses of $17.0 million and an increase in amortization expense of $7.4
million.
Basic earnings per common share ("Basic EPS") of $0.49 for the three months
ended July 1, 2022 increased $0.16 from the prior year period. Diluted earnings
per common share ("Diluted EPS") of $0.49 for the three months ended July 1,
2022 increased $0.16 from the prior year period. The increases were primarily
attributable to an increase in operating income.
Basic EPS of $1.02 for the six months ended July 1, 2022 increased $0.37 from
the prior year period. Diluted EPS of $1.01 for the six months ended July 1,
2022 increased $0.37 from the prior year period. The increases were primarily
attributable to an increase in operating income, partially offset by an increase
in income tax provision.
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Revenue
The following table sets forth external revenue by reportable segment for the
periods noted (dollars in thousands):
Three Months Ended
July 1, July 2, Increase Percentage
2022 2021 (Decrease) Change
Photonics $ 69,461 $ 62,357 $ 7,104 11.4 %
Vision 65,516 63,447 2,069 3.3 %
Precision Motion 80,379 41,719 38,660 92.7 %
Total $ 215,356 $ 167,523 $ 47,833 28.6 %
Six Months Ended
July 1, July 2, Increase Percentage
2022 2021 (Decrease) Change
Photonics $ 132,243 $ 120,851 $ 11,392 9.4 %
Vision 127,566 131,083 (3,517 ) (2.7 )%
Precision Motion 159,763 78,173 81,590 104.4 %
Total $ 419,572 $ 330,107 $ 89,465 27.1 %
Photonics
Photonics segment revenue for the three months ended July 1, 2022 increased by
$7.1 million, or 11.4%, versus the prior year period, primarily due to increased
demand in advanced industrial and medical markets.
Photonics segment revenue for the six months ended July 1, 2022 increased by
$11.4 million, or 9.4%, versus the prior year period, primarily due to increased
demand in advanced industrial and medical markets.
Vision
Vision segment revenue for the three months ended July 1, 2022 increased by $2.1
million, or 3.3%, versus the prior year period, primarily due to increases in
sales from our minimally invasive surgery products.
Vision segment revenue for the six months ended July 1, 2022 decreased by $3.5
million, or 2.7%, versus the prior year period, primarily due to raw material
shortage and other supply chain disruptions.
Precision Motion
Precision Motion segment revenue for the three months ended July 1, 2022
increased by $38.7 million, or 92.7%, versus the prior year period, primarily
due to $34.9 million of revenue contributions from 2021 acquisitions and
increased demand in advanced industrial and medical markets.
Precision Motion segment revenue for the six months ended July 1, 2022 increased
by $81.6 million, or 104.4%, versus the prior year period, primarily due to
$67.8 million of revenue contributions from 2021 acquisitions and increased
demand in advanced industrial and medical markets.
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Gross Profit and Gross Profit Margin
The following table sets forth the gross profit and gross profit margin for each
of our reportable segments for the periods noted (dollars in thousands):
Three Months Ended Six Months Ended
July 1, July 2, July 1, July 2,
2022 2021 2022 2021
Gross profit:
Photonics $ 31,182 $ 29,593 $ 59,569 $ 57,702
Vision 26,535 24,443 51,765 51,369
Precision Motion 38,864 20,874 77,014 36,951
Unallocated Corporate and Shared Services (1,336 ) (2,504 ) (2,827 ) (4,876 )
Total $ 95,245 $ 72,406 $ 185,521 $ 141,146
Gross profit margin:
Photonics 44.9 % 47.5 % 45.0 % 47.7 %
Vision 40.5 % 38.5 % 40.6 % 39.2 %
Precision Motion 48.4 % 50.0 % 48.2 % 47.3 %
Total 44.2 % 43.2 % 44.2 % 42.8 %
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, trade
tariffs, freight costs, headcount, inventory obsolescence and warranty expenses.
Photonics
Photonics segment gross profit for the three months ended July 1, 2022 increased
$1.6 million, or 5.4%, versus the prior year period, primarily due to an
increase in revenue. Photonics segment gross profit margin was 44.9% for the
three months ended July 1, 2022 versus a gross profit margin of 47.5% for the
prior year period. The decrease in gross profit margin was primarily
attributable to supply chain disruptions and overall raw material cost
inflation.
Photonics segment gross profit for the six months ended July 1, 2022 increased
$1.9 million, or 3.2%, versus the prior year period, primarily due to an
increase in revenue. Photonics segment gross profit margin was 45.0% for the six
months ended July 1, 2022 versus a gross profit margin of 47.7% for the prior
year period. The decrease in gross profit margin was primarily attributable to
supply chain disruptions and overall raw material cost inflation.
Vision
Vision segment gross profit for the three months ended July 1, 2022 increased
$2.1 million, or 8.6%, versus the prior year period, primarily due to an
increase in both revenue and gross profit margin. Vision segment gross profit
margin was 40.5% for the three months ended July 1, 2022, versus a gross profit
margin of 38.5% for the prior year period. The increase in gross profit margin
was primarily attributable to improved factory efficiency.
Vision segment gross profit for the six months ended July 1, 2022 increased $0.4
million, or 0.8%, versus the prior year period, primarily due to an increase in
gross profit margin. Vision segment gross profit margin was 40.6% for the six
months ended July 1, 2022, versus a gross profit margin of 39.2% for the prior
year period. The increase in gross profit margin was primarily attributable to
improved factory efficiency.
Precision Motion
Precision Motion segment gross profit for the three months ended July 1, 2022
increased $18.0 million, or 86.2%, versus the prior year period, primarily due
to an increase in revenue. Precision Motion segment gross profit margin was
48.4% for the three months ended July 1, 2022, versus a gross profit margin of
50.0% for the prior year period. The decrease in gross profit margin was
primarily attributable to an increase in amortization of purchased intangible
assets.
Precision Motion segment gross profit for the six months ended July 1, 2022
increased $40.1 million, or 108.4%, versus the prior year period, primarily due
to an increase in both revenue and gross profit margin. Precision Motion segment
gross profit margin was 48.2% for the six months ended July 1, 2022, versus a
gross profit margin of 47.3% for the prior year period. The increase in
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gross profit margin was primarily attributable to improved factory efficiency
and utilization, offset by an increase in amortization of purchased intangible
assets.
Unallocated Corporate and Shared Services
Unallocated corporate and shared services costs primarily represent costs of
corporate and shared services functions that are not allocated to the operating
segments. These costs for the three months ended July 1, 2022 decreased by $1.2
million versus the prior year period primarily due to reduced COVID-19 testing
costs for employees of $1.4 million.
Unallocated corporate and shared services costs for the six months ended July 1,
2022 decreased by $2.1 million versus the prior year period primarily due to
reduced COVID-19 testing costs for employees of $2.7 million.
Operating Expenses
The following table sets forth operating expenses for the periods noted (in
thousands):
Three Months Ended Six Months Ended
July 1, July 2, July 1, July 2,
2022 2021 2022 2021
Research and development and
engineering $ 21,588 $ 16,954 $ 42,517 $ 35,636
Selling, general and administrative 40,538 31,240 79,890 62,893
Amortization of purchased intangible
assets
7,173 3,586 14,515 7,161
Restructuring, acquisition, and
related costs 2,655 4,634 1,025 8,365
Total $ 71,954 $ 56,414 $ 137,947 $ 114,055
Research and Development and Engineering Expenses
Research and Development and Engineering ("R&D") expenses are primarily
comprised of employee compensation related expenses and cost of materials for
R&D projects. R&D expenses were $21.6 million, or 10.0% of revenue, during the
three months ended July 1, 2022, versus $17.0 million, or 10.1% of revenue,
during the prior year period. R&D expenses increased in terms of total dollars
primarily due to expenses related to 2021 acquisitions.
R&D expenses were $42.5 million, or 10.1% of revenue, during the six months
ended July 1, 2022, versus $35.6 million, or 10.8% of revenue, during the prior
year period. R&D expenses increased in terms of total dollars primarily due to
expenses related to 2021 acquisitions.
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 functions. SG&A expenses were
$40.5 million, or 18.8% of revenue, during the three months ended July 1, 2022,
versus $31.2 million, or 18.6% of revenue, during the prior year period. SG&A
expenses increased in terms of total dollars primarily due to SG&A expenses
related to 2021 acquisitions and increases in variable compensation and
discretionary spending.
SG&A expenses were $79.9 million, or 19.0% of revenue, during the six months
ended July 1, 2022, versus $62.9 million, or 19.1% of revenue, during the prior
year period. SG&A expenses increased in terms of total dollars primarily due to
SG&A expenses related to 2021 acquisitions and increases in variable
compensation and discretionary spending.
Amortization of Purchased Intangible Assets
Amortization of purchased intangible assets, excluding amortization of developed
technologies that is included in cost of revenue, was $7.2 million, or 3.3% of
revenue, during the three months ended July 1, 2022, versus $3.6 million, or
2.1% of revenue, during the prior year period. The increase, in terms of total
dollars and as a percentage of revenue, was the result of more acquired
intangible assets from 2021 acquisitions.
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Amortization of purchased intangible assets, excluding amortization of developed
technologies that is included in cost of revenue, was $14.5 million, or 3.5% of
revenue, during the six months ended July 1, 2022, versus $7.2 million, or 2.2%
of revenue, during the prior year period. The increase, in terms of total
dollars and as a percentage of revenue, was the result of more acquired
intangible assets from 2021 acquisitions.
Restructuring, Acquisition, and Related Costs
We recorded restructuring, acquisition, and related costs of $2.7 million during
the three months ended July 1, 2022, versus $4.6 million during the prior year
period. The acquisition and related costs decreased primarily due to a $1.4
million reduction in acquisition and related expenses and a $0.8 million
reduction in legal fees, partially offset by a $0.9 million increase in earnout
expenses related to prior year acquisitions. The restructuring costs decreased
$0.6 million related to decreased expenses for the 2020 restructuring plan.
We recorded restructuring, acquisition, and related costs of $1.0 million during
the six months ended July 1, 2022, versus $8.4 million during the prior year
period. The acquisition and related costs decreased primarily due to a $2.4
million reduction in earnout expenses related to prior year acquisitions, a $1.8
million reduction in legal fees and a $1.5 million reduction in other
acquisition and related expenses. The restructuring costs decreased $1.5 million
related to decreased expenses for the 2020 restructuring plan.
Operating Income (Loss) by Segment
The following table sets forth operating income (loss) by segment for the
periods noted (in thousands):
Three Months Ended Six Months Ended
July 1, July 2, July 1, July 2,
2022 2021 2022 2021
Operating Income (Loss)
Photonics $ 13,996 $ 14,196 $ 27,431 $ 26,591
Vision 7,024 3,206 12,066 6,572
Precision Motion 14,083 12,279 32,421 19,724
Unallocated Corporate and Shared Services (11,812 ) (13,689 ) (24,344 ) (25,796 )
Total $ 23,291 $ 15,992 $ 47,574 $ 27,091
Photonics
Photonics segment operating income was $14.0 million, or 20.1% of revenue,
during the three months ended July 1, 2022, versus $14.2 million, or 22.8% of
revenue, during the prior year period. The decrease in operating income was
primarily due to an increase in R&D costs of $1.1 million and an increase in
S&GA expenses of $0.4 million, partially offset by an increase in gross profit
of $1.6 million.
Photonics segment operating income was $27.4 million, or 20.7% of revenue,
during the six months ended July 1, 2022, versus $26.6 million, or 22.0% of
revenue, during the prior year period. The increase in operating income was
primarily due to an increase in gross profit of $1.9 million, and a decrease in
restructuring, acquisition, and related charges of $1.1 million, partially
offset by an increase in R&D costs of $1.0 million and an increase in S&GA
expenses of $0.9 million.
Vision
Vision segment operating income was $7.0 million, or 10.7% of revenue, during
the three months ended July 1, 2022, versus $3.2 million, or 5.1% of revenue,
during the prior year period. The increase in operating income was primarily due
to an increase in gross profit of $2.1 million and a decrease in restructuring,
acquisition, and related charges of $1.3 million.
Vision segment operating income was $12.1 million, or 9.5% of revenue, during
the six months ended July 1, 2022, versus $6.6 million, or 5.0% of revenue,
during the prior year period. The increase in operating income was primarily due
to a decrease in restructuring, acquisition, and related charges of $2.9
million, a decrease in R&D costs of $1.4 million, a decrease in amortization
expense of 0.8 million, and an increase in gross profit of $0.4 million.
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Precision Motion
Precision Motion segment operating income was $14.1 million, or 17.5% of
revenue, during the three months ended July 1, 2022, versus $12.3 million, or
29.4% of revenue, during the prior year period. The increase in operating income
was primarily due to an increase in gross profit of $18.0 million, partially
offset by increases in R&D spending of $3.8 million, SG&A expenses of $8.0
million, and amortization expense of $4.0 million primarily as a result of prior
year acquisitions.
Precision Motion segment operating income was $32.4 million, or 20.3% of
revenue, during the six months ended July 1, 2022, versus $19.7 million, or
25.2% of revenue, during the prior year period. The increase in operating income
was primarily due to an increase in gross profit of $40.1 million, and a
decrease in restructuring, acquisition, and related charges of $1.6 million,
partially offset by increases in R&D spending of $7.3 million, SG&A expenses of
$13.7 million, and amortization expense of $8.0 million primarily as a result of
prior year acquisitions.
Unallocated Corporate and Shared Services
Unallocated corporate and shared services costs primarily represent costs of
corporate and shared services functions that are not allocated to the operating
segments, including certain restructuring and most acquisition costs. These
costs for the three months ended July 1, 2022 decreased by $1.9 million versus
the prior year period primarily due to a decrease in costs related to COVID-19
testing for employees of $1.4 million included in cost of revenue, and a
decrease in restructuring, acquisition, and related charges of $1.5 million,
partially offset by an increase in SG&A expenses of $0.8 million.
Unallocated corporate and shared services costs for the six months ended July 1,
2022 decreased by $1.5 million versus the prior year period primarily due to a
decrease in costs related to COVID-19 testing for employees of $2.7 million
included in cost of revenue, and a decrease in restructuring, acquisition, and
related charges of $1.7 million, partially offset by an increase in SG&A
expenses of $2.4 million.
Other Income and Expense Items
The following table sets forth other income and expense items for the periods
noted (in thousands):
Three Months Ended Six Months Ended
July 1, July 2, July 1, July 2,
2022 2021 2022 2021
Interest income (expense), net $ (2,757 ) $ (1,378 ) $ (5,866 ) $ (2,786 )
Foreign exchange transaction gains
(losses), net
$ 152 $ (76 ) $ 221 $ (333 )
Other income (expense), net $ 68 $ (97 ) $ (477 ) $ (167 )
Interest Income (Expense), Net
Net interest expense was $2.8 million for the three months ended July 1, 2022,
versus $1.4 million in the prior year period. The increase in net interest
expense was primarily due to an increase in average debt levels and an increase
in the weighted average interest rate on our senior credit facilities. The
weighted average interest rate on our senior credit facilities was 2.29% during
the three months ended July 1, 2022, versus 2.04% during the prior year period.
Net interest expense was $5.9 million for the six months ended July 1, 2022,
versus $2.8 million in the prior year period. The increase in net interest
expense was primarily due to an increase in average debt levels and an increase
in the weighted average interest rate on our senior credit facilities. The
weighted average interest rate on our senior credit facilities was 2.39% during
the six months ended July 1, 2022, versus 2.03% during the prior year period.
Foreign Exchange Transaction Gains (Losses), Net
Foreign exchange transaction gains (losses) were nominal for both the three and
six months ended July 1, 2022 and the three and six months ended July 2, 2021.
Other Income (Expense), Net
Net other expense was nominal for the three months ended July 1, 2022 and July
2, 2021. The increase in other expense for the six months ended July 1, 2022
compared to the prior year comparable period was primarily due to a $0.6 million
loss from the write-off of a portion of the unamortized deferred financing cost
as a result of the Fifth Amendment.
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Income Tax Provision (Benefit)
Our effective tax rate for the three months ended July 1, 2022 was 15.8%, versus
19.2% for the prior year period. Our effective tax rate of 15.8% for the three
months ended July 1, 2022 differs from the Canadian statutory tax rate of 29.0%
primarily due to the mix of income earned in jurisdictions with varying tax
rates, estimated deductions for Foreign Derived Intangible Income, U.K. patent
box deductions, and R&D tax credits, partially offset by disallowed compensation
and uncertain tax position accruals.
Our effective tax rate of 19.2% for the three months ended July 2, 2021, differs
from the Canadian statutory tax rate of 29.0% primarily due to the mix of income
earned in jurisdictions with varying tax rates, estimated deductions for Foreign
Derived Intangible Income, U.K. patent box deductions, other tax credits, and a
release of uncertain tax position reserves, offset by the revaluation of long
term deferred tax balances resulting from the U.K. corporate tax rate change.
Our effective tax rate for the six months ended July 1, 2022 was 12.4%, versus
3.5% for the prior year period. Our effective tax rate of 12.4% for the six
months ended July 1, 2022 differs from the Canadian statutory tax rate of 29.0%
primarily due to the mix of income earned in jurisdictions with varying tax
rates, estimated deductions for Foreign Derived Intangible Income, U.K. patent
box deductions, R&D tax credits and windfall tax benefits upon vesting of
certain share-based compensation awards, partially offset by disallowed
compensation and uncertain tax position accruals. For the six months ended July
1, 2022, the windfall tax benefits upon vesting of certain stock-based
compensation awards had a benefit of 1.4% on our effective tax rate.
Our effective tax rate of 3.5% for the six months ended July 2, 2021, differs
from the Canadian statutory tax rate of 29.0% primarily due to the mix of income
earned in jurisdictions with varying tax rates, estimated deductions for Foreign
Derived Intangible Income, U.K. patent box deductions, other tax credits, a
release of uncertain tax positions reserves, and windfall tax benefits upon
vesting of certain share-based compensation awards, partially offset by the
revaluation of long term deferred tax balances resulting from the U.K. corporate
tax rate change during the period. For the six months ended July 2, 2021, the
windfall tax benefits upon vesting of certain share-based compensation awards
had a benefit of 14.7% on our effective tax rate.
Beginning in January 2022, the Tax Cuts and Jobs Act of 2017 ("TCJA") requires
R&D expenditures be capitalized and amortized for income tax purposes over five
years for domestic research and fifteen years for foreign research, rather than
being deducted as incurred. This has the effect of increasing our cash taxes and
deferred tax assets. Since January 2022, the Company has recognized deferred tax
assets of $6.3 million for the relevant R&D expenditures. This provision also
has an indirect benefit of 3% on our effective tax rate for the six months ended
July 1, 2022, as our estimated deductions for Foreign Derived Intangible Income
has increased as a result of increased U.S. taxable income. The provision for
income taxes for both the three months and the six months ended July 1, 2022
reflects the impact of the TCJA.
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 our 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 option under our
revolving credit agreement. We may also 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 (as amended, the "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 the COVID-19 pandemic, worsening 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, higher interest rates in the U.S. and
Europe, 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 our Annual Report on Form 10-K for the
fiscal year ended December 31, 2021.
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Our cash requirements primarily consist of the principal and interest payments
associated with our Senior Credit Facilities, operating and finance leases,
purchase commitments, pension obligations, contingent considerations and
earn-outs. Such contractual obligations are described in our Management's
Discussion and Analysis of Financial Condition and Results of Operations and in
the Notes to Consolidated Financial Statements, each included in our Annual
Report on Form 10-K for the fiscal year ended December 31, 2021. Through July 1,
2022, we have not entered into any other material new or modified contractual
obligations since December 31, 2021.
Our ability to make payments on our indebtedness and to fund our operations may
be dependent upon the earnings and the distribution of funds from our
subsidiaries. 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 applicable laws and regulations and/or
the terms of our indebtedness will permit our subsidiaries to provide us with
sufficient dividends, distributions or loans when necessary.
As of July 1, 2022, $72.5 million of our $100.5 million cash and cash
equivalents was held by subsidiaries outside of Canada and the U.S. 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 (as defined below). Approximately
$144.8 million of our outstanding term loan and revolver borrowings under our
Senior Credit Facilities were held in our subsidiaries outside of Canada and the
U.S. Additionally, we may use intercompany loans to address short-term cash flow
needs for various subsidiaries.
We deferred certain U.S. payroll tax payments in 2020 in accordance with relief
provisions under the CARES Act. We paid $1.4 million of such deferred payroll
tax payments in December 2021. As permitted under the CARES Act, we expect to
pay the remaining $1.4 million deferred U.S. Payroll taxes by December 31, 2022.
Senior Credit Facilities
In December 2019, we entered into the Credit Agreement, consisting of a $100.0
million U.S. dollar equivalent euro-denominated 5-year term loan facility
(approximately €90.2 million) and a $350.0 million 5-year revolving credit
facility (collectively, the "Senior Credit Facilities"). The Senior Credit
Facilities mature in December 2024 and included an uncommitted accordion option
pursuant to which the commitments under the revolving credit facility may be
increased by an additional $200.0 million in aggregate, subject to certain
customary conditions. The term loan facility requires quarterly scheduled
principal repayments of approximately €1.1 million beginning 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 outstanding borrowings under our revolving credit
facility with cash on hand and cash generated from future operations at any
time.
In March 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 option. 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 option to $200.0 million for potential future expansion.
On October 5, 2021, the Company entered into an amendment (the "Fourth
Amendment") to the Third Amended and Restated Credit Agreement to exercise the
accordion option. 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 option to $200.0 million for potential future expansion.
On March 10, 2022, the Company entered into an amendment (the "Fifth Amendment")
to the 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 option from $200 million to $350 million.
As of July 1, 2022, we had $82.2 million term loan and $330.6 million revolver
borrowings outstanding under our Senior Credit Facilities. The borrowings
outstanding under the Senior Credit Facilities bear interest at rates based on
(a) the Base Rate, as defined in the Credit Agreement, plus a margin ranging
between 0.00% and 0.75% per annum, determined by reference to our consolidated
leverage ratio, or (b) the Eurocurrency Rate, as defined in the 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 July 1, 2022, we had outstanding borrowings
under the Credit Agreement denominated in Euro and U.S. Dollars of $144.8
million and $268.0 million, respectively.
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The Credit Agreement contains various covenants that we believe are usual and
customary for this type of agreement, including a maximum consolidated leverage
ratio and a minimum consolidated fixed charge coverage ratio (as defined in the
Credit Agreement). The following table summarizes these financial covenants and
our compliance therewith as of July 1, 2022:
Requirement Actual
Maximum consolidated leverage ratio (1) 3.50 2.23
Minimum consolidated fixed charge coverage ratio 1.50 9.83
(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.
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 October 2018, our Board of Directors approved a share repurchase plan (the
"2018 Repurchase Plan") authorizing the repurchase of $25.0 million worth of
common shares. Share repurchases have been made under the 2018 Repurchase Plan
pursuant to Rule 10b-18 under the Securities Exchange Act of 1934. During the
six months ended July 1, 2022, we repurchased 80 thousand shares for an
aggregate purchase price of $9.5 million at an average price of $118.97 per
share under the 2018 Repurchase Plan. As of July 1, 2022, we had repurchased a
cumulative total of 264 thousand shares under the 2018 Repurchase Plan for an
aggregate purchase price of $25.0 million at an average price of $94.57 per
share. As of July 1, 2022, we had completed the 2018 Repurchase Plan.
In February 2020, our Board of Directors approved a new share repurchase plan
(the "2020 Repurchase Plan") authorizing the repurchase of an additional $50.0
million worth of common shares. Share repurchases have been made under the 2020
Repurchase Plan pursuant to Rule 10b-18 under the Securities Exchange Act of
1934. During the six months ended July 1, 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. As of July 1, 2022, we had $49.5
million available for share repurchases under the 2020 Repurchase Plan.
Cash Flows for the Six Months Ended July 1, 2022 and July 2, 2021
The following table summarizes our cash flows, cash and cash equivalents, and
unused and available funds under our revolving credit facility for the periods
indicated (in thousands):
Six Months Ended
July 1, July 2,
2022 2021
Net cash provided by operating activities $ 35,408 $ 52,014
Net cash used in investing activities $ (12,616 ) $ (10,843 )
Net cash used in financing activities $ (35,473 ) $ (31,994 )
July 1, December 31,
2022 2021
Cash and cash equivalents $ 100,489 $ 117,393
Unused and available funds under the revolving credit
facility $ 364,441 $ 348,421
Operating Cash Flows
Cash provided by operating activities was $35.4 million for the six months ended
July 1, 2022, versus $52.0 million for the prior year period. Cash provided by
operating activities for the six months ended July 1, 2022 decreased from the
prior year period primarily due to a $33.5 million increase in inventories
driven by increased customer demand and higher critical raw material
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purchases, and a bonus payout in 2022 of $8.4 million compared to no bonus
payout in 2021 as a result of the elimination of our 2020 annual bonus plan,
partially offset by an increase in profit before tax from higher revenue.
Beginning in January 2022, the Tax Cuts and Jobs Act of 2017 ("TCJA") requires
R&D expenditures be capitalized and amortized for income tax purposes over five
years for domestic research and fifteen years for foreign research, rather than
being deducted as incurred. This has the effect of increasing our cash taxes and
deferred tax assets. If this provision under the TCJA is not deferred, modified,
or repealed with retroactive effect going back to January 1, 2022, our operating
cash flows are expected to decrease by approximately $10.2 million for the year
ending December 31, 2022.
Investing Cash Flows
Cash used in investing activities was $12.6 million for the six months ended
July 1, 2022, primarily driven by capital expenditures of $12.1 million and a
contingent consideration payment of $1.5 million related to our 2016 asset
acquisition of video signal processing and management technologies.
Cash used in investing activities was $10.8 million for the six months ended
July 2, 2021, primarily driven by capital expenditures of $8.6 million and a
contingent consideration payment of $2.2 million related to our 2016 asset
acquisition of video signal processing and management technologies.
We expect to use an aggregate of approximately $25 million to $30 million in
2022 for capital expenditures related to investments in new property, plant and
equipment for our existing businesses.
Financing Cash Flows
Cash used in financing activities was $35.5 million for the six months ended
July 1, 2022, primarily due to $10 million of repurchase of common stock, $9.5
million of payroll tax payments upon vesting of share-based compensation awards,
$12.8 million of term loan and revolving credit facility repayments, and $2.5
million of debt issuance costs in connection with the Fifth Amendment.
Cash used in financing activities was $32.0 million for the six months ended
July 2, 2021, primarily due to $18.4 million of payroll tax payments upon
vesting of share-based compensation awards, an $8.7 million payment for the
purchase of a building under a finance lease agreement, $2.7 million of term
loan repayments, and $1.8 million of contingent consideration payments related
to acquisitions.
Critical Accounting Policies and Estimates
The critical accounting policies that we believe impact significant judgments
and estimates used in the preparation of our consolidated financial statements
presented in this periodic report on Form 10-Q are described in our Management's
Discussion and Analysis of Financial Condition and Results of Operations and in
the Notes to Consolidated Financial Statements, each included in our Annual
Report on Form 10-K for the fiscal year ended December 31, 2021. There have been
no material changes to our critical accounting policies and estimates through
July 1, 2022 from those disclosed in our Annual Report on Form 10-K for the
fiscal year ended December 31, 2021.
Recent Accounting Pronouncements
See Note 1 to Consolidated Financial Statements.
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