Novanta Inc: Form 10-Q for the period ended Sep 29, 2023

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, our ability to manage or mitigate the impact of global supply chain disruptions, inflationary pressures and other macroeconomic conditions; 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; industry trends; market conditions; our competitive positions; changes in economic and political conditions, including supply chain disruptions and constraints and inflationary pressures; changes in accounting principles; changes in actual or assumed tax liabilities and tax law; expectations regarding tax exposures; anticipated reinvestment of future earnings and dividend policy; anticipated expenditures in regard to the Company’s benefit plans; future acquisitions and integration and anticipated benefits from acquisitions and dispositions; anticipated economic benefits and expected costs of restructuring programs; ability to repay our indebtedness; our intentions regarding the use of cash; expectations regarding legal and regulatory requirements, including environmental requirements, and our compliance thereto; and other statements that are not historical facts. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various important factors, including, 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 epidemics or pandemics, such as 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; our reliance on original equipment manufacturer customers; 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; 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, 2022 under the heading “Risk Factors”, as updated herein and 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.

Accounting Period

The interim consolidated financial statements of Novanta Inc. (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 precision medicine and manufacturing, medical solutions, and robotics and automation with a proven ability to solve complex technical challenges. This enables us to engineer core components and sub-systems that deliver extreme precision and performance, tailored to our customers' demanding applications.

During the first quarter of 2023, we changed the names of our reportable segments from “Photonics” to “Precision Medicine and Manufacturing”, from “Vision” to “Medical Solutions”, and from “Precision Motion” to “Robotics and Automation”, respectively. The segment name changes did not result in any change to the compositions of our segments and therefore did not result in any change to historical results.

Reportable Segments

We operate in three reportable segments: Precision Medicine and Manufacturing, Medical Solutions, and Robotics and Automation. The reportable segments and their principal activities are summarized below.

Precision Medicine and Manufacturing

Our Precision Medicine and Manufacturing 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.

Medical Solutions

Our Medical Solutions 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.

Robotics and Automation

Our Robotics and Automation 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 nine months ended September 29, 2023, the medical market accounted for approximately 54% of our revenue. Revenue from our products sold to the medical market is generally affected by hospital and other healthcare provider capital spending, growth rates of surgical procedures, changes in regulatory requirements and laws, aggregation of purchasing by healthcare networks, changes in technology requirements, timing of OEM customers’ product development and new product launches, changes in customer or patient preferences, and general demographic trends.

Advanced Industrial Market

For the nine months ended September 29, 2023, the advanced industrial market accounted for approximately 46% of our revenue. Revenue from our products sold to the advanced industrial market is affected by 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 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 functionality to long life-cycle OEM customer platforms in attractive medical and advanced industrial niche markets;
• improving our business mix to increase medical sales as a percentage of total revenue by:
• introducing new products aimed at attractive medical applications, such as minimally invasive and robotic surgery, ophthalmology, patient monitoring, drug delivery, clinical laboratory testing and life science equipment;
• deepening our key account management relationships with and driving cross selling of our product offerings to leading medical equipment manufacturers; and
• pursuing complementary medical technology acquisitions;
• increasing our penetration of high growth advanced industrial applications, such as laser materials processing, intelligent end-of-arm robotic technology solutions, robotics, laser additive manufacturing, automation and metrology, by working closely with OEM customers to launch application specific products that closely match the requirements of each application;
• broadening our portfolio of enabling proprietary technologies and capabilities through increased investment in new product development, and investments in application development to further penetrate existing customers, while expanding the applicability of our solutions to new markets;
• broadening our product and service offerings through the acquisition of innovative and complementary technologies and solutions in medical and advanced industrial technology applications;
• expanding sales and marketing channels to reach new target customers;
• improving our existing operations to expand profit margins and improve customer satisfaction by implementing lean manufacturing principles, strategic sourcing across our major production sites; and optimizing and limiting the growth of our fixed cost base; and
• attracting, retaining, and developing world-class talented, diverse, and motivated employees.

Significant Events and Updates

Business Environment

Global Supply Chain Disruptions

Over the past three years, we 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 could further challenge our ability to manufacture our products, adversely affecting our operations and customer relationships. To mitigate the risk of supply chain interruptions, we are identifying alternative suppliers and distributors, sourcing raw materials from different supplier and distributor locations, modifying our product designs to allow for alternative components to be used without compromising quality and performance, in-sourcing production of parts where feasible, and taking other actions to ensure a sustainable supply of raw materials. 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 for obtaining raw materials from suppliers. Our supply chain disruptions and customer orders to secure supply caused significantly elevated customer order backlog levels in the last two years. Although we have seen some decrease in our backlog coverage levels throughout the year, they are still higher than average historical levels and we anticipate that our customers will continue to gradually shorten their order lead times as supply chain disruptions ease further in the near future.

Inflationary Pressures

The COVID-19 pandemic and the global supply chain disruptions have caused inflationary pressures on the market prices for raw materials and components as well as increases in the costs of labor. We continue to experience higher than normal inflation of raw materials and components prices and labor costs. We have generally been able to offset increases in these costs through various productivity cost reduction initiatives, as well as increasing our selling prices to pass through some of these higher costs to our customers. However, our ability to raise our selling prices depends on market conditions and competitive dynamics. Given the timing of our actions compared to the timing of these inflationary pressures, there may be periods during which we are unable to fully recover the increases in our costs. Additionally, the inflationary pressures have given rise to significant increases in interest rates as various governments used monetary policy to reduce inflation. As a result, our weighted average interest rate increased from approximately 2.7% as of September 30, 2022 to approximately 6.1% as of September 29, 2023.

Geopolitical Conflicts

In February 2022, Russian forces invaded Ukraine. In response, the U.S., the European Union (“EU”), and several other countries imposed economic and trade sanctions and other restrictions (collectively, “global sanctions”) targeting Russia and Belarus. Russia then imposed retaliatory economic measures against the U.S., the EU, and several other countries. Our historical sales to Russia were not material. We also do not have any assets, employees or third-party contractors in Russia or Ukraine. However, the duration of the conflict and further sanctions could have further impact on the global economy and inflation. Due to the uncertainty around the duration of the conflict, the impacts of these longer-term factors to our business are unknown.

In early October 2023, Israel declared war on Hamas after the Palestinian militant group launched a surprise cross-boarder raid in Israel. We are monitoring the social, political and economic environment in Israel and in the region for any impact on our businesses. Our historical sales to Israel were around 1% of our total sales. We do not have any assets, employees, or third-party contractors in Israel. Due to the uncertainty around the duration of the conflict, future impacts are unknown to our businesses.

Results of Operations for the Three and Nine Months Ended September 29, 2023 Compared with the Three and Nine Months Ended September 30, 2022

Overview of Financial Results

Total revenue of $221.5 million for the three months ended September 29, 2023 decreased $1.5 million, or 0.7%, from the prior year period primarily due to decreased demand in the advanced industrial markets, partially offset by increased demand in the medical markets and revenue from a prior year acquisition. The effect of our prior year acquisition resulted in an increase in revenue of $1.3 million, or 0.6%. In addition, foreign currency exchange rates favorably impacted our revenue by $4.6 million, or 2.0%, for the three months ended September 29, 2023.

Total revenue of $670.1 million for the nine months ended September 29, 2023 increased $27.6 million, or 4.3%, from the prior year period primarily due to increased demand in the medical markets and revenue from a prior year acquisition. The effect of our prior year acquisition resulted in an increase in revenue of $8.1 million, or 1.3%. In addition, foreign currency exchange rates adversely impacted our revenue by $1.3 million, or 0.2%, for the nine months ended September 29, 2023.

Operating income of $30.3 million for the three months ended September 29, 2023 increased $1.6 million, or 5.7%, from the prior year period. This increase was attributable to an increase in gross profit of $3.2 million primarily due to an increase in gross profit margin, a decrease in amortization expense of $1.3 million, and a decrease in selling, general and administrative expenses of $0.7 million, partially offset by an increase in restructuring, acquisition, and related costs of $2.9 million and an increase in research and development and engineering expenses of $0.7 million.

Operating income of $88.8 million for the nine months ended September 29, 2023 increased $12.6 million, or 16.5%, from the prior year period. This increase was attributable to an increase in gross profit of $19.4 million primarily due to higher revenue and gross profit margin and a $5.6 million decrease in amortization expense, partially offset by an increase in restructuring, acquisition, and related charges of $5.5 million, an increase in research and development and engineering expenses of $4.4 million, and an increase in selling, general and administrative expenses of $2.6 million.

Basic earnings per common share (“Basic EPS”) of $0.59 for the three months ended September 29, 2023 decreased $0.04 from the prior year period. Diluted earnings per common share (“Diluted EPS”) of $0.59 for the three months ended September 29, 2023 decreased $0.04 from the prior year period. The decreases were primarily due to an increase in interest expense, partially offset by a decrease in income tax provision.

Basic earnings per common share (“Basic EPS”) of $1.68 for the nine months ended September 29, 2023 increased $0.03 from the prior year period. Diluted earnings per common share (“Diluted EPS”) of $1.68 for the nine months ended September 29, 2023 increased $0.04 from the prior year period. The increases were primarily attributable to an increase in operating income and a decrease in income tax provision, partially offset by an increase in interest expense.

Revenue

The following table sets forth external revenue by reportable segment for the periods noted (dollars in thousands):

Precision Medicine and Manufacturing

Precision Medicine and Manufacturing segment revenue for the three months ended September 29, 2023 increased $0.5 million, or 0.7%, versus the prior year period, primarily due to increased demand in medical markets, partially offset by weaker demand in advanced industrial markets.

Precision Medicine and Manufacturing segment revenue for the nine months ended September 29, 2023 increased $12.1 million, or 6.0%, versus the prior year period, primarily due to increased demand in medical markets.

Medical Solutions

Medical Solutions segment revenue for the three months ended September 29, 2023 increased $10.0 million, or 13.7%, versus the prior year period, primarily due to increases in sales from our minimally invasive surgery products and detection and analysis products, and $1.3 million of revenue contributions from our 2022 acquisition.

Medical Solutions segment revenue for the nine months ended September 29, 2023 increased $43.4 million, or 21.6%, versus the prior year period, primarily due to increases in sales from our minimally invasive surgery products and detection and analysis products, and $8.1 million of revenue contributions from our 2022 acquisition.

Robotics and Automation

Robotics and Automation segment revenue for the three months ended September 29, 2023 decreased $12.0 million, or 15.2%, versus the prior year period, primarily due to a decrease in demand in advanced industrial markets, especially microelectronics markets.

Robotics and Automation segment revenue for the nine months ended September 29, 2023 decreased $28.0 million, or 11.7%, versus the prior year period, primarily due to a decrease in demand in advanced industrial markets, especially microelectronics markets.

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):

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.

Precision Medicine and Manufacturing

Precision Medicine and Manufacturing segment gross profit for the three months ended September 29, 2023 increased $1.5 million, or 4.3%, versus the prior year period, primarily due to an increase in both revenue and gross profit margin. Precision Medicine and Manufacturing segment gross profit margin was 50.8% for the three months ended September 29, 2023, versus a gross profit margin of 49.0% for the prior year period. The increase in gross profit margin was attributable to favorable product mix and the impact of business interruption insurance recovery payments, partially offset by an increase in inventory reserves as a result of a demand decline in the advanced industrial market and higher cost of poor quality.

Precision Medicine and Manufacturing segment gross profit for the nine months ended September 29, 2023 increased $12.8 million, or 13.6%, versus the prior year period, primarily due to an increase in both revenue and gross profit margin. Precision Medicine and Manufacturing segment gross profit margin was 49.8% for the nine months ended September 29, 2023, versus a gross profit margin of 46.4% for the prior year period. The increase in gross profit margin was primarily attributable to improved factory productivity, favorable product mix and the impact of business interruption insurance recovery payments, partially offset by an increase in inventory reserves as a result of a demand decline in the advanced industrial market and higher cost of poor quality.

Medical Solutions

Medical Solutions segment gross profit for the three months ended September 29, 2023 increased $5.8 million, or 20.7%, versus the prior year period, primarily due to an increase in both revenue and gross profit margin. Medical Solutions segment gross profit margin was 40.8% for the three months ended September 29, 2023, versus a gross profit margin of 38.4% for the prior year period. The increase in gross profit margin was primarily attributable to improved factory efficiency.

Medical Solutions segment gross profit for the nine months ended September 29, 2023 increased $20.2 million, or 25.3%, versus the prior year period, primarily due to an increase in both revenue and gross profit margin. Medical Solutions segment gross profit margin was 41.0% for the nine months ended September 29, 2023, versus a gross profit margin of 39.8% for the prior year period. The increase in gross profit margin was primarily attributable to improved factory efficiency.

Robotics and Automation

Robotics and Automation segment gross profit for the three months ended September 29, 2023 decreased $4.2 million, or 11.3%, versus the prior year period, primarily due to a decrease in revenue. Robotics and Automation segment gross profit margin was 48.8% for the three months ended September 29, 2023, versus a gross profit margin of 46.7% for the prior year period. The increase in gross profit margin was primarily attributable to improved factory efficiency and disciplined cost control.

Robotics and Automation segment gross profit for the nine months ended September 29, 2023 decreased $13.5 million, or 11.8%, versus the prior year period, primarily due to a decrease in revenue. Robotics and Automation segment gross profit margin remained flat at 47.7% for the nine months ended September 29, 2023 versus the prior year period.

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 September 29, 2023 decreased less than $0.1 million versus the prior year period.

Unallocated corporate and shared services costs for the nine months ended September 29, 2023 increased $0.1 million versus the prior year period.

Operating Expenses

The following table sets forth operating expenses for the periods noted (in thousands):

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 $22.0 million, or 9.9% of revenue, during the three months ended September 29, 2023, versus $21.3 million, or 9.6% of revenue, during the prior year period. R&D expenses increased in terms of total dollars and as a percentage of revenue, primarily due to higher compensation related expenses as a result of salary increases and higher headcount.

R&D expenses were $68.2 million, or 10.2% of revenue, during the nine months ended September 29, 2023, versus $63.9 million, or 9.9% of revenue, during the prior year period. R&D expenses increased in terms of total dollars and as a percentage of revenue, primarily due to higher compensation related expenses as a result of salary increases and higher headcount.

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 $39.6 million, or 17.9% of revenue, during the three months ended September 29, 2023, versus $40.3 million, or 18.1% of revenue, during the prior year period. SG&A expenses decreased in terms of total dollars primarily due to decreases in variable compensation expense and disciplined cost control.

SG&A expenses were $122.8 million, or 18.3% of revenue, during the nine months ended September 29, 2023, versus $120.2 million, or 18.7% of revenue, during the prior year period. SG&A expenses increased in terms of total dollars primarily due to increases in compensation related expenses and discretionary spending.

Amortization of Purchased Intangible Assets

Amortization of purchased intangible assets, excluding amortization of developed technologies which is included in cost of revenue, was $5.1 million, or 2.3% of revenue, during the three months ended September 29, 2023, versus $6.5 million, or 2.9% of revenue, during the prior year period. The decrease in terms of total dollars and as a percentage of revenue was primarily due to certain intangible assets being fully amortized in 2022.

Amortization of purchased intangible assets, excluding amortization of developed technologies which is included in cost of revenue, was $15.3 million, or 2.3% of revenue, during the nine months ended September 29, 2023, versus $21.0 million, or 3.3% of revenue, during the prior year period. The decrease in terms of total dollars and as a percentage of revenue was primarily due to certain intangible assets being fully amortized in 2022.

Restructuring, Acquisition, and Related Costs

We recorded restructuring, acquisition, and related costs of $4.5 million during the three months ended September 29, 2023, versus $1.6 million during the prior year period. During the three months ended September 29, 2023, the restructuring costs increased $2.6 million primarily related to impairment of assets and an increase in severance and related costs.

We recorded restructuring, acquisition, and related costs of $8.2 million during the nine months ended September 29, 2023, versus $2.7 million during the prior year period. The restructuring costs increased $4.9 million primarily related to an increase in severance and related costs.

Operating Income (Loss) by Segment

The following table sets forth operating income (loss) by segment for the periods noted (in thousands):

Precision Medicine and Manufacturing

Precision Medicine and Manufacturing segment operating income was $18.5 million, or 26.0% of revenue, during the three months ended September 29, 2023, versus $18.4 million, or 25.9% of revenue, during the prior year period. The increase in operating income was primarily due to an increase in gross profit of $1.5 million, partially offset by an increase in restructuring, acquisition, and related costs of $0.9 million and an increase in SG&A expenses of $0.5 million.

Precision Medicine and Manufacturing segment operating income was $54.8 million, or 25.5% of revenue, during the nine months ended September 29, 2023, versus $45.8 million, or 22.5% of revenue, during the prior year period. The increase in operating income was primarily due to an increase in gross profit of $12.8 million, partially offset by an increase in restructuring, acquisition, and related costs of $3.0 million and an increase in SG&A expenses of $1.0 million.

Medical Solutions

Medical Solutions segment operating income was $11.0 million, or 13.3% of revenue, during the three months ended September 29, 2023, versus $8.7 million, or 11.9% of revenue, during the prior year period. The increase in operating income was primarily due to an increase in gross profit of $5.8 million, partially offset by an increase in R&D expenses of $2.1 million and an increase in SG&A expenses of $1.5 million.

Medical Solutions segment operating income was $31.0 million, or 12.7% of revenue, during the nine months ended September 29, 2023, versus $20.8 million, or 10.4% of revenue, during the prior year period. The increase in operating income was primarily due to an increase in gross profit of $20.2 million and a decrease in amortization expense of $0.8 million, partially offset by an increase in R&D expenses of $6.4 million and an increase in SG&A expenses of $4.3 million.

Robotics and Automation

Robotics and Automation segment operating income was $12.2 million, or 18.3% of revenue, during the three months ended September 29, 2023, versus $15.8 million, or 20.0% of revenue, during the prior year period. The decrease in operating income was primarily due to a decrease in gross profit of $4.2 million and an increase restructuring, acquisition, and related costs of $2.0 million, partially offset by a decrease in R&D expenses of $1.1 million and a decrease in amortization expense of $1.1 million due to certain intangible assets being fully amortized in 2022.

Robotics and Automation segment operating income was $39.5 million, or 18.7% of revenue, during the nine months ended September 29, 2023, versus $48.2 million, or 20.2% of revenue, during the prior year period. The decrease in operating income was primarily due to a decrease in gross profit of $13.5 million and an increase of restructuring, acquisition, and related costs of $2.3 million, partially offset by a decrease in amortization expense of $4.7 million due to certain intangible assets being fully amortized in 2022, a decrease in R&D expenses of $1.5 million and a decrease in SG&A expenses of $0.9 million.

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 September 29, 2023 decreased $2.8 million versus the prior year period. The decrease in operating loss was primarily due to disciplined cost control and lower variable compensation costs.

Unallocated corporate and shared services costs for the nine months ended September 29, 2023 decreased $2.2 million versus the prior year period. The decrease in operating loss was primarily due to disciplined cost control and lower variable compensation costs.

Other Income and Expense Items

The following table sets forth other income and expense items for the periods noted (in thousands):

Interest Income (Expense), Net

Net interest expense was $6.8 million for the three months ended September 29, 2023, versus $4.1 million for the prior year period. The increase in net interest expense was primarily due to an increase in the weighted average interest rate on our senior credit facilities. The weighted average interest rate on our senior credit facilities was 6.68% during the three months ended September 29, 2023, versus 3.37% during the prior year period.

Net interest expense was $19.9 million for the nine months ended September 29, 2023, versus $9.9 million for the prior year period. The increase in net interest expense was primarily due to an increase in the weighted average interest rate on our senior credit facilities. The weighted average interest rate on our senior credit facilities was 6.12% during the nine months ended September 29, 2023, versus 2.72% during the prior year period.

Foreign Exchange Transaction Gains (Losses), Net

Foreign exchange transaction gains (losses) were $(0.4) million net loss for the three months ended September 29, 2023, versus $2.1 million net gain in the prior year period. The prior period net gain was primarily due to changes in the value of the U.S. Dollar against the British Pound and Euro.

Foreign exchange transaction gains (losses) were $(0.4) million net loss for the nine months ended September 29, 2023, versus $2.3 million net gain in the prior year period. The prior period net gain was primarily due to changes in the value of the U.S. Dollar against the British Pound and Euro.

Other Income (Expense), Net

Net other expense was nominal for both the three and nine months ended September 29, 2023 and the three and nine months ended September 30, 2022.

Income Tax Provision (Benefit)

Our effective tax rate for the three months ended September 29, 2023 was 7.7%, versus 16.0% for the prior year period. Our effective tax rate of 7.7% for the three months ended September 29, 2023 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 tax benefits of share-based compensation awards, partially offset by disallowed compensation deductions and uncertain tax position accruals.

Our effective tax rate of 16.0% for the three months ended September 30, 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, partially offset by disallowed compensation deductions and uncertain tax position accruals.

Our effective tax rate for the nine months ended September 29, 2023, was 11.2%, versus 13.8% for the prior year period. Our effective tax rate of 11.2% for the nine months ended September 29, 2023 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 tax benefits of share-based compensation awards, partially offset by disallowed compensation deductions and uncertain tax position accruals. For the nine months ended September 29, 2023, the tax benefits of stock-based compensation awards had a benefit of 4.5% on our effective tax rate.

Our effective tax rate of 13.8% for the nine months ended September 30, 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 tax benefits of share-based compensation awards, partially offset by disallowed compensation deductions and uncertain tax position accruals. For the nine months ended September 30, 2022, the tax benefits of stock-based compensation awards had a benefit of 0.2% on our effective tax rate.

On December 12, 2022, the EU member states agreed to implement the Pillar Two Model Rules developed by the Organization for Economic Co-operation and Development (“OECD”) with an effective date of January 2024. Other countries are also actively considering changes to their tax laws to adopt certain parts of the OECD’s proposals. These rules will impose a global corporate minimum income tax rate of 15%. The OECD continues to release additional guidance on these rules. The Company is analyzing the potential impact and will continue to monitor the related developments.

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 global pandemics and geopolitical conflicts, monetary policy changes in the U.S. and other countries and their impact on the global financial markets, supply chain disruptions and electronics and other material shortages, a decrease in demand for our products, our ability to integrate current and future acquisitions, deterioration in certain financial ratios, availability of borrowings under our revolving credit facility, and other 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, 2022.

Our cash requirements primarily consist of principal and interest payments associated with our Senior Credit Facilities (as defined below), operating and finance leases, purchase commitments, and pension obligations. 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, 2022. Through September 29, 2023, we have not entered into any other material new or modified contractual obligations since December 31, 2022.

Our ability to make payments on our indebtedness and to fund our operations may be dependent upon the operating income and the distribution of funds from our subsidiaries. However, as local laws and regulations and/or the terms of our indebtedness restrict certain of our subsidiaries from paying dividends and transferring assets to us, there is no assurance that our subsidiaries will be permitted to provide us with sufficient dividends, distributions or loans when necessary.

As of September 29, 2023, $49.9 million of our $76.0 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. Approximately $124.6 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.

Senior Credit Facilities

In December 2019, we entered into the Third Amended and Restated Credit Agreement, originally consisting of a $100.0 million U.S. dollar equivalent euro-denominated (approximately €90.2 million) 5-year term loan facility and a $350.0 million 5-year revolving credit facility (collectively, the “Senior Credit Facilities”). The Senior Credit Facilities had an original maturity date of 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.

On March 27, 2020, we entered into an amendment (the “First Amendment”) to the Credit Agreement and exercised a portion of the uncommitted accordion option. The First Amendment increased the revolving credit facility commitment under the 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 Credit Agreement to exercise the accordion option. The Fourth Amendment increased the revolving credit facility commitment under the 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 September 29, 2023, we had $77.2 million term loan and $279.4 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 Term SOFR Loans, Alternative Currency Loans, and Letters of Credit 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 September 29, 2023, we had outstanding borrowings under the Credit Agreement denominated in Euro and U.S. Dollars of $124.6 million and $232.0 million, respectively.

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 September 29, 2023:

(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 February 2020, our Board of Directors approved a new share repurchase plan (the “2020 Repurchase Plan”) authorizing the repurchase of $50.0 million worth of common shares. Share repurchases have been made under the 2020 Repurchase Plan pursuant to Rule 10b-18 under the Securities Exchange Act of 1934. The Company did not repurchase any shares during the nine months ended September 29, 2023. As of September 29, 2023, we had $49.5 million available for share repurchases under the 2020 Repurchase Plan.

Cash Flows for the Nine Months Ended September 29, 2023 and September 30, 2022

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):

Operating Cash Flows

Cash provided by operating activities was $81.1 million for the nine months ended September 29, 2023, versus $50.2 million for the prior year period. Cash provided by operating activities for the nine months ended September 29, 2023 increased from the prior year period primarily as a result of less cash outflows from changes in net working capital, partially offset by higher income tax payments, higher interest payments, and higher incentive compensation payments.

Investing Cash Flows

Cash used in investing activities was $13.7 million for the nine months ended September 29, 2023, all related to capital expenditures.

Cash used in investing activities was $38.3 million for the nine months ended September 30, 2022, primarily driven by the $22.4 million of cash consideration (net of cash acquired) paid for the acquisition of MPH Medical Devices S.R.O.(“MPH”). We also paid for capital expenditures of $15.4 million and contingent consideration of $1.5 million related to our 2016 asset acquisition of video signal processing and management technologies.

We expect to use an aggregate of approximately $22 million to $24 million in 2023 for capital expenditures related to investments in new property, plant and equipment for our existing businesses, which includes a significant one-time buildout project in the U.K. for our Solid State and Ultrafast Lasers products.

Financing Cash Flows

Cash used in financing activities was $92.8 million for the nine months ended September 29, 2023, primarily due to $82.0 million of term loan and revolving credit facility repayments and $10.1 million of payroll tax payments upon vesting of share-based compensation awards.

Cash used in financing activities was $36.7 million for the nine months ended September 30, 2022, primarily due to $46.3 million of contingent consideration payments related to prior year acquisitions, $37.8 million of term loan and revolving credit facility repayments, $10.0 million of repurchases of common stock, $9.6 million of payroll tax payments upon vesting of share-based compensation awards, and $2.5 million of debt issuance costs in connection with the Fifth Amendment, partially offset by $69.9 million of borrowings under our revolving credit facility used to fund the contingent consideration paid for the acquisition of ATI Industrial Automation Inc. and cash consideration paid for the MPH acquisition.

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, 2022. There have been no material changes to our critical accounting policies and estimates through September 29, 2023 from those disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

Recent Accounting Pronouncements

See Note 1 to Consolidated Financial Statements.

Our primary market risk exposures are foreign currency exchange rate fluctuations and interest rate sensitivity. During the three months ended September 29, 2023, there have been no material changes to the information included under Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15(b) under the Securities and Exchange Act of 1934 (the “Exchange Act”), our management carried out an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of September 29, 2023, the end of the period covered by this report. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of September 29, 2023.

Changes in Internal Control Over Financial Reporting

There has been no change to our internal control over financial reporting during the fiscal quarter ended September 29, 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

The Company’s risk factors are described in Part I, Item 1A, “Risk Factors”, of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022. The risks described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial position, or future results of operations. The risk factors set forth below update, and should be read together with, the risk factors described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.

Our results of operations could be adversely affected by economic and political conditions and the effects of these conditions on our customers’ businesses, capital expenditures and levels of business activities.

A large portion of our product sales are dependent on our customers’ need for increased capacity, productivity and cost saving initiatives, improved product quality and performance, and new investments. Weaknesses in our end markets could negatively impact our revenue and gross margin and consequently have a material adverse effect on our business, financial condition and results of operations. A severe and/or prolonged overall economic downturn or a negative or uncertain political climate could lead to weaknesses in our end markets and adversely affect our customers’ financial condition and the timing or levels of our customers’ capital expenditures or business activities. We have experienced significant cyclical end market fluctuations in the past. For example, diminished growth expectations, economic and political uncertainty in regions across the globe and effects of the COVID-19 pandemic adversely impacted our customers’ financial condition and ability to maintain product order levels and reduced the demand for our products in 2020. In addition, certain sub-segments of the advanced industrial market that we serve, including the microelectronics and industrial capital equipment sectors, are cyclical and have historically experienced periods of oversupply, resulting in downturns in demand for capital equipment in which many of our products are used. It is difficult to predict the timing, length and severity of these downturns and their impact on our business. Further, our order levels or results of operations for a given period may not be indicative of order levels or results of operations for subsequent periods. For the foreseeable future, our operations will continue to depend upon industries that are subject to market cycles which, in turn, could adversely affect the market demand for our products.

We have also faced increases in inflationary conditions in materials and components as well as labor costs, and we expect these inflationary conditions to continue at least for the remainder of 2023. These inflationary conditions have caused us to increase prices; however, such price increases may not be accepted by our customers or may not adequately offset the increases in our costs, thereby negatively affecting our results of operations. Changes in global economic conditions, including inflationary conditions, could also shift market demand to products or services for which we do not have competitive advantages. This could negatively affect the amount of business that we are able to obtain. In addition, if we are unable to successfully anticipate changes in economic and political conditions, we may be unable to effectively plan for and respond to those changes, and our business could be negatively affected.

Adverse developments that affect financial institutions, transactional counterparties, or other third parties, or concerns or rumors about these events, have in the past and may in the future lead to market-wide liquidity problems. Uncertainty may remain over liquidity concerns in the broader financial services industry, and there may be unpredictable impacts to our business and our industry.