NOVANTA INC 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the Consolidated Financial Statements and Notes included in Item 8 of this Annual Report on Form 10-K. The MD&A contains certain forward looking statements within the meaning of the United States Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. These forward-looking statements include, but are not limited to, anticipated impacts of the COVID-19 pandemic on our business, financial results and 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; changes in accounting principles; changes in actual or assumed tax liabilities; expectations regarding tax exposures; anticipated reinvestment of future earnings and dividend policy; anticipated expenditures in regard to the Company’s benefit plans; future acquisitions and integration and anticipated benefits from acquisitions and dispositions; anticipated economic benefits and expected costs of restructuring programs; ability to repay our indebtedness; our intentions regarding the use of cash; expectations regarding legal and regulatory requirements and our compliance thereto; and other statements that are not historical facts. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various important factors, including those set forth in Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors.” The words “anticipates,” “believes,” “expects,” “intends,” “future,” “could,” “estimates,” “plans,” “would,” “should,” “potential,” “continues,” and similar words or expressions (as well as other words or expressions referencing future events, conditions or circumstances) identify forward looking statements. Readers should not place undue reliance on any such forward looking statements, which speak only as of the date they are made. Management and the Company disclaim any obligation to publicly update or revise any such statements to reflect any change in its expectations or in events, conditions, or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those contained in the forward looking statements, except as required under applicable law. Business Overview Novanta Inc. and its subsidiaries (collectively referred to as, the “Company”, “Novanta”, “we”, “us”, “our”) is a leading global supplier of core technology solutions that give medical and advanced industrial original equipment manufacturers (“OEMs”) a competitive advantage. We combine deep proprietary technology expertise and competencies in 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. End Markets We primarily operate in two end markets: the medical market and the advanced industrial market. Medical Market For the year ended December 31, 2020, the medical market accounted for approximately 56% 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. Approximately 70% of our medical end market sales are related to surgical procedures, both elective and emergency based. Advanced Industrial Market For the year ended December 31, 2020, the advanced industrial market accounted for approximately 44% of our revenue. Revenue from our products sold to the advanced industrial market is affected by a number of factors, including changing technology requirements and preferences of our customers, productivity or quality investments in a manufacturing environment, the financial condition of our customers, changes in regulatory requirements and laws, and general economic conditions. We believe that the Purchasing Managers Index (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. 34 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, 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, including increasing our recurring revenue streams such as services, spare parts and consumables; • 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 27, 2020, we entered into an amendment (the “First Amendment”) to the third amended and restated credit agreement, dated as of December 31, 2019 (as amended, the “Third Amended and Restated Credit Agreement”). Our Third Amended and Restated Credit Agreement provides for an aggregate credit facility of $450.0 million, comprised 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 First Amendment exercised a portion of the $200 million uncommitted accordion feature under the Third Amended and Restated Credit Agreement and increased the revolving credit facility commitment by $145 million, from $350 million to $495 million. Additionally, the uncommitted accordion feature was reset to $200 million for potential future expansion. Impact of COVID-19 on Our Business Our Employees 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 facilities to provide leadership for and manage our COVID-19 risk mitigation actions and countermeasures. We have provided frequent employee communications that include guidance and updates to our employees with regards to COVID-19 safety procedures and status. We established rigorous safety measures in all of our facilities, including implementing social distancing protocols, requiring working from home for those employees that do not need to be physically present on the manufacturing floor or in our facilities to perform their work, suspending travel, spreading production over more shifts, implementing temperature checks at the entrances to our facilities, frequently disinfecting our workspaces, and providing masks to those employees who must be physically present in our facilities. We expect to continue these measures until we determine that the COVID-19 pandemic is adequately contained for purposes of our business. In connection with our COVID-19 remediation actions, we have incurred additional costs to protect the health of our employees, including investment in technologies and monitoring equipment. We expect such costs to continue to grow and be significant to our 35 cost of operations. We may take further actions as government authorities require or recommend or as we determine to be in the best interest of our employees. We are committed to retaining and supporting our employees during this pandemic. To retain our employees, we issued to all of our employees, other than the Chief Executive Officer, the Chief Financial Officer, the Chief Human Resource Officer and the Chief Accounting Officer, a special one-time restricted stock unit grant in April 2020 at a total fair value of $14.4 million in the aggregate. The restricted stock units vested in February 2021. These actions were implemented to create an ownership mindset and focus among all employees for the duration of the COVID-19 pandemic and through the expected recovery, while maintaining the Company’s talent and capabilities. Executive Compensation The Compensation Committee of our Board of Directors approved the 2020 compensation plans for our executive officers and a Section 16 officer (collectively, the “Officers”) in February 2020. To support our business during the COVID-19 pandemic, the Officers agreed to a reduction in cash compensation for 2020. Further, the Officers did not receive the special one-time restricted stock unit grant issued to the rest of the employees. In June 2020, our Board of Directors agreed to forgo the cash retainers payable to our non-employee directors for the third quarter of 2020. Our Customers The outbreak has significantly increased economic and demand uncertainty. The spread of COVID-19 has caused a global economic slowdown and a global recession. In 2020, the decline in customer demand in both medical and advanced industrial end markets resulted in a decrease in sales to many of our customers. In the event of a further prolonged economic recession, overall demand for our products could decline further in the near term and our business would be adversely affected to a greater extent. Our Facilities Because of the COVID-19 pandemic, governmental authorities worldwide implemented numerous evolving measures to try to contain the spread of the virus, such as travel bans and restrictions, limits on social gatherings, quarantines, shelter-in-place orders, business shutdowns and social distancing. We have important manufacturing operations in the U.S., the U.K., Germany, and China, all of which have been affected by the COVID-19 pandemic. As of December 31, 2020, our manufacturing facilities around the world were in operation. While governmental measures may be modified or extended in the event of a resurgence of COVID-19 infections, the spread of new variants of the virus, and delays in effective vaccination of a large proportion of the populations, we have taken measures to protect our employees and expect our manufacturing facilities to remain operational. In connection with the COVID-19 pandemic, we have experienced limited absenteeism from those employees who are required to be on site to perform their jobs. Our Supply Chain We have experienced limited disruption to our supply chain as a result of the COVID-19 pandemic to date. We regularly monitor the financial health and manufacturing output of companies in our supply chain. Hardship on our suppliers or sub-suppliers caused by the COVID-19 pandemic could cause further disruption in our ability to obtain raw materials or components required to manufacture our products, adversely affecting our operations. To mitigate the risk of any potential supply interruptions from the COVID-19 pandemic, we are identifying alternative suppliers, sourcing raw materials from different supplier locations, and taking other actions to ensure our supply of raw materials. Although we are mitigating potential supply interruptions from the COVID-19 pandemic, if certain suppliers cannot produce a key 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 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. Our Liquidity With respect to liquidity, we have taken actions to reduce costs and cash expenditures across the Company. These actions included reducing hiring activities, restricting travel, adjusting employee compensation by eliminating fiscal year 2020 cash bonuses and base salary increases, implementing an unpaid time-off program for substantially all of our non-production workforce, limiting discretionary spending, reducing or deferring spending on capital investment projects, deferring lease payments on certain facilities, and deferring certain U.S. payroll tax payments in accordance with relief provisions under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). As of December 31, 2020, we deferred $2.8 million in certain U.S. payroll tax payments under the CARES Act. Due to the uncertainty related to the future impact of the COVID-19 pandemic, we temporarily suspended repurchases under our share repurchase plans in April 2020. 36 As of December 31 , 2020, we had cash and cash equivalents of $125. 1 million and available borrowing capacity under our revolving credit facility of $395.2 million. We have reviewed numerous potential scenarios in connection with the impact of COVID-19 on our business. Based on our analysis, we believe our existing balances of cash and cash equivalents, anticipated cash flows from our operating activities, and available borrowing capacity under our revolving credit facility will be sufficient to meet our cash needs arising in the ordinary course of business for the next twelve months. Additionally, we believe we will remain in compliance with our debt covenants for the next twelve months. Overview of Financial Results Total revenue for 2020 was $590.6 million, a decrease of $35.5 million, or 5.7%, versus 2019. This decrease was primarily due to the COVID-19 pandemic as we experienced decreased demand in the advanced industrial market related to reductions in industrial manufacturing spending and in the medical market as a result of deferrals of elective surgical procedures. The effect of our acquisitions in 2019 resulted in an increase in revenue of $8.4 million, or 1.3%. In addition, foreign exchange rates positively impacted our revenue by $3.7 million, or 0.6%, in 2020. Operating income increased $0.6 million from $55.3 million in 2019 to $55.9 million in 2020. This increase was primarily attributable to a decrease of selling, general and administrative (“SG&A”) expenses of $8.6 million and a decrease in restructuring and acquisition related costs of $12.8 million, offset by a decrease in gross profit of $17.6 million as a result of lower revenue and an increase in research and development and engineering (“R&D”) spending of $5.0 million. Basic earnings per common share (“basic EPS”) of $1.27 in 2020 increased $0.11 from the basic EPS of $1.16 in 2019. Diluted earnings per common share (“diluted EPS”) of $1.25 in 2020 increased $0.10 from the diluted EPS of $1.15 in 2019. The increase of basic EPS and diluted EPS was primarily attributable to decreases in interest expense and income tax provision. Specific components of our operating results for 2020, 2019 and 2018 are further discussed below. Results of Operations The following table sets forth our results of operations as a percentage of revenue for the years indicated: 2020 2019 2018 Revenue 100.0 % 100.0 % 100.0 % Cost of revenue 58.6 58.1 57.4 Gross profit 41.4 41.9 42.6 Operating expenses: Research and development and engineering 10.3 8.9 8.3 Selling, general and administrative 18.6 18.9 18.9 Amortization of purchased intangible assets 2.4 2.5 2.5 Restructuring and acquisition related costs 0.6 2.6 1.3 Total operating expenses 31.9 33.0 31.0 Operating income 9.5 8.8 11.6 Interest income (expense), net (1.1 ) (1.4 ) (1.6 ) Foreign exchange transaction gains (losses), net (0.2 ) (0.1 ) 0.0 Other income (expense), net 0.0 (0.0 ) (0.0 ) Income before income taxes 8.2 7.3 10.0 Income tax provision 0.7 0.8 1.7 Consolidated net income 7.5 6.5 8.3 Less: Net income attributable to noncontrolling interest — - (0.3 ) Net income attributable to Novanta Inc. 7.5 % 6.5 % 8.0 % 37 Revenue The following table sets forth external revenue by reportable segment for 2020, 2019 and 2018 (dollars in thousands): % Change 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 Photonics $ 199,613 $ 230,457 $ 249,339 (13.4 )% (7.6 )% Vision 261,650 271,407 232,902 (3.6 )% 16.5 % Precision Motion 129,360 124,235 132,096 4.1 % (6.0 )% Total $ 590,623 $ 626,099 $ 614,337 (5.7 )% 1.9 % Photonics Photonics segment revenue in 2020 decreased by $30.8 million, or 13.4%, versus 2019, primarily due to decreased demand in the advanced industrial market related to reductions in global industrial manufacturing spending and in the medical market as a result of deferrals of elective surgical procedures and a reduction in certain medical diagnostic testing during the COVID-19 pandemic. Photonics segment revenue in 2019 decreased by $18.9 million, or 7.6%, versus 2018, primarily due to decreased demand in the advanced industrial market related to reductions in global industrial manufacturing spending, and a decrease in revenue from our optical light engine products, partially offset by $4.9 million of revenue from the acquisition of ARGES in July 2019. Vision Vision segment revenue in 2020 decreased by $9.8 million, or 3.6%, versus 2019, primarily due to a decrease in revenue from our minimally invasive surgery (“MIS”) products as a result of deferrals of elective surgical procedures during the COVID-19 pandemic. Vision segment revenue in 2019 increased by $38.5 million, or 16.5%, versus 2018. The increase was primarily due to an increase in revenue of $28.4 million from our minimally invasive surgery products as a result of new product introductions and increased demand in the medical market and $5.4 million of revenue from the acquisition of Med X Change in June 2019 . Precision Motion Precision Motion segment revenue in 2020 increased by $5.1 million, or 4.1%, versus 2019, primarily due to an increase in revenue related to increased demand by microelectronics customers, partially offset by decreased demand in the medical market as a result of deferrals of elective surgical procedures during the COVID-19 pandemic. Precision Motion segment revenue in 2019 decreased by $7.9 million, or 6.0%, versus 2018. The decrease was primarily due to decreased demand in the microelectronics and industrial market related to reductions in global industrial manufacturing spending, partially offset by increased demand in the medical market and the acquisitions of Ingenia in April 2019 and Zettlex Holdings Limited (“Zettlex”) in May 2018. 38 Gross Profit The following table sets forth the gross profit and gross profit margin for each of our reportable segments for 2020, 2019 and 2018 (dollars in thousands): 2020 2019 2018 Gross profit: Photonics $ 89,060 $ 105,845 $ 117,109 Vision 100,267 105,228 87,198 Precision Motion 58,279 53,326 59,477 Unallocated Corporate and Shared Services (3,089 ) (2,314 ) (2,256 ) Total $ 244,517 $ 262,085 $ 261,528 Gross profit margin: Photonics 44.6 % 45.9 % 47.0 % Vision 38.3 % 38.8 % 37.4 % Precision Motion 45.1 % 42.9 % 45.0 % Total 41.4 % 41.9 % 42.6 % Gross profit and gross profit margin can be influenced by a number of factors, including product mix, pricing, volume, manufacturing efficiencies and utilization, costs for raw materials and outsourced manufacturing, headcount, inventory obsolescence and warranty expenses. Photonics Photonics segment gross profit for 2020 decreased $16.8 million, or 15.9%, versus 2019, primarily due to a decrease in revenue. Photonics segment gross profit margin was 44.6% for 2020, compared with a gross profit margin of 45.9% for 2019. The decrease in gross profit margin was primarily attributable to lower factory utilization associated with lower production volumes and higher costs as a result of the COVID-19 pandemic. Photonics segment gross profit for 2019 decreased $11.3 million, or 9.6%, versus 2018, primarily due to a decrease in revenue. Photonics segment gross profit margin was 45.9% for 2019, compared with a gross profit margin of 47.0% for 2018. The decrease in gross profit margin was primarily attributable to changes in product mix. Amortization of inventory fair value adjustments and amortization of developed technologies increased $1.1 million, which resulted in a 0.5 percentage point decrease in gross profit margin. Vision Vision segment gross profit for 2020 decreased $5.0 million, or 4.7%, versus 2019, primarily due to a decrease in revenue. Vision segment gross profit margin was 38.3% for 2020, compared with a gross profit margin of 38.8% for 2019. The decrease in gross profit margin was primarily attributable to unfavorable product mix changes as a result of the COVID-19 pandemic. Vision segment gross profit for 2019 increased $18.0 million, or 20.7%, versus 2018, primarily due to an increase in revenue. Vision segment gross profit margin was 38.8% for 2019, compared with a gross profit margin of 37.4% for 2018. The increase in gross profit margin was primarily attributable to increased utilization of our German facility and cost reductions in our optical data collection products, partially offset by the cost of a redundant manufacturing facility in San Jose, California until the transfer of our manufacturing activities was substantially completed at the end of 2019. Precision Motion Precision Motion segment gross profit for 2020 increased $5.0 million, or 9.3%, versus 2019, primarily due to an increase in revenue. Precision Motion segment gross profit margin was 45.1% for 2020, compared with a gross profit margin of 42.9% for 2019. The increase in gross profit margin was primarily attributable to favorable product and customer mix changes as well as productivity improvements implemented during 2020. Precision Motion segment gross profit for 2019 decreased $6.2 million, or 10.3%, versus 2018, primarily due to a decrease in revenue and a decrease in gross profit margin. Precision Motion segment gross profit margin was 42.9% for 2019, compared with a gross profit margin of 45.0% for 2018. The decrease in gross profit margin was primarily attributable to business volume reductions that could not be fully compensated by cost reduction initiatives. 39 Operating Expenses The following table sets forth operating expenses for 2020, 2019 and 2018 (dollars in thousands): % Change 2020 2019 2018 2020 vs. 2019 2019 vs. 2018 Research and development and engineering $ 60,996 $ 55,965 $ 51,024 9.0 % 9.7 % Selling, general and administrative 109,853 118,407 115,900 (7.2 )% 2.2 % Amortization of purchased intangible assets 13,970 15,857 15,550 (11.9 )% 2.0 % Restructuring and acquisition related costs 3,810 16,574 8,041 (77.0 )% 106.1 % Total $ 188,629 $ 206,803 $ 190,515 (8.8 )% 8.5 % Research and Development and Engineering Expenses Research and development and engineering (“R&D”) expenses are primarily comprised of employee compensation and related expenses and cost of materials for R&D projects. R&D expenses were $61.0 million, or 10.3% of revenue in 2020, versus $56.0 million, or 8.9% of revenue in 2019. R&D expenses increased in terms of total dollars and as a percentage of revenue primarily due to R&D expenses added from 2019 acquisitions, higher R&D project spending and higher share-based compensation expense offset by lower cash compensation and a reduction in discretionary spending. R&D expenses were $56.0 million, or 8.9% of revenue in 2019, versus $51.0 million, or 8.3% of revenue in 2018. R&D expenses increased in terms of total dollars and as a percentage of revenue primarily due to R&D expenses added from acquisitions and higher investments in R&D. Selling, General and Administrative Expenses Selling, general and administrative (“SG&A”) expenses include costs for sales and marketing, sales administration, finance, human resources, legal, information systems and executive management. SG&A expenses were $109.9 million, or 18.6% of revenue, in 2020, versus $118.4 million, or 18.9% of revenue in 2019. SG&A expenses decreased in terms of total dollars and as a percentage of revenue primarily due to lower cash compensation and lower discretionary spending, partially offset by higher share-based compensation expense. SG&A expenses were $118.4 million, or 18.9% of revenue in 2019, versus $115.9 million, or 18.9% of revenue in 2018. SG&A expenses increased in terms of total dollars primarily due to SG&A expenses added from acquisitions and higher professional services spending, partially offset by lower variable compensation expense. Amortization of Purchased Intangible Assets Amortization of purchased intangible assets is charged to our Photonics, Vision and Precision Motion segments. Amortization of developed technologies is included in cost of revenue in the consolidated statement of operations. Amortization of customer relationships, trademarks, trade names, backlog and other intangibles are included in operating expenses in the consolidated statement of operations. Amortization of purchased intangible assets, excluding the amortization of developed technologies that is included in cost of revenue, was $14.0 million, or 2.4% of revenue in 2020, versus $15.9 million, or 2.5% of revenue in 2019. The decrease in terms of total dollars was the result of certain acquired intangible assets being fully amortized at the end of 2019. Amortization of purchased intangible assets, excluding the amortization of developed technologies that is included in cost of revenue, was $15.9 million, or 2.5% of revenue, in 2019, versus $15.6 million, or 2.5% of revenue in 2018. The increase in terms of total dollars was the result of acquired intangible assets from acquisitions in 2018 and 2019. Restructuring and Acquisition Related Costs Restructuring and acquisition related charges primarily relate to our restructuring programs, acquisition related costs incurred for completed acquisitions, acquisition costs related to future potential acquisitions and failed acquisitions, and changes in fair value of contingent considerations. 40 We recorded restructuring and acquisition related costs of $3.8 million in 2020, versus $16.6 million in 2019. The decrease in restructuring and acquisition related costs versus 2019 was primarily due to a decrease in restructuring charge s of $4.2 million and a decrease in acquisition and related cost s of $8.6 million. The decrease in acquisition and related costs was primarily attributable to the reduction in fair value of the contingent considerations in 2020 related to 2019 acquisitions and higher professional services fees for acquisitions during 2019 , offset by legal fees during 2020 related to a dispute involving a company we acquired in 2019. We recorded restructuring and acquisition related costs of $16.6 million in 2019, versus $8.0 million in 2018. The increase in restructuring and acquisition related costs in 2019 versus 2018 was primarily due to an increase in restructuring charges of $6.6 million as a result of the 2018 and 2019 restructuring programs and an increase in acquisition related costs of $1.9 million primarily related to an increase in professional services fees, partially offset by a decrease in costs recognized under earn-out agreements. Operating Income (Loss) by Segment The following table sets forth operating income (loss) by segment for 2020, 2019 and 2018 (in thousands): 2020 2019 2018 Operating Income (Loss) Photonics $ 34,001 $ 41,990 $ 59,285 Vision 16,354 21,007 8,991 Precision Motion 31,663 22,339 31,674 Unallocated Corporate and Shared Services (26,130 ) (30,054 ) (28,937 ) Total $ 55,888 $ 55,282 $ 71,013 Photonics Photonics segment operating income was $34.0 million, or 17.0% of revenue, in 2020, versus $42.0 million, or 18.2% of revenue, in 2019. The decrease in operating income was primarily due to a decrease in gross profit of $16.8 million and an increase in R&D spending of $2.5 million, partially offset by a decrease in SG&A expense of $1.9 million, a decrease in restructuring and acquisition related charges of $7.1 million, and a decrease in amortization of purchased intangible assets of $2.3 million. Photonics segment operating income was $42.0 million, or 18.2% of revenue, in 2019, versus $59.3 million, or 23.8% of revenue, in 2018. The decrease in operating income was primarily due to a decrease in gross profit of $11.3 million, an increase in R&D expenses of $2.1 million and restructuring related charges of $5.0 million associated with the 2019 restructuring program, including a $2.2 million impairment of an operating lease right-of-use asset. Vision Vision segment operating income was $16.4 million, or 6.3% of revenue, in 2020, versus $21.0 million, or 7.7% of revenue, in 2019. The decrease in operating income was primarily due to a decrease in gross profit of $5.0 million, an increase in R&D spending of $2.6 million, and an increase in restructuring and acquisition related charges of $1.6 million, partially offset by a decrease of SG&A expenses of $4.8 million. Vision segment operating income was $21.0 million, or 7.7% of revenue, in 2019, versus $9.0 million, or 3.9% of revenue, in 2018. The increase in operating income was primarily due to an increase in gross profit of $18.0 million, partially offset by an increase in R&D expenses of $1.6 million and SG&A expenses of $2.8 million. Vision segment operating income was negatively affected by a $0.9 million net increase in amortization of inventory fair value adjustments and amortization of intangible assets. Precision Motion Precision Motion segment operating income was $31.7 million, or 24.5% of revenue, in 2020, versus $22.3 million, or 18.0% of revenue, in 2019. The increase in operating income was primarily due to an increase in gross profit of $5.0 million, a decrease in SG&A expenses of $1.5 million, and a decrease in restructuring and acquisition related charges of $2.9 million. Precision Motion segment operating income was $22.3 million, or 18.0% of revenue, in 2019, versus $31.7 million, or 24.0% of revenue, in 2018. The decrease in operating income was primarily due to a decrease in gross profit of $6.2 million, an increase in R&D expenses of $1.3 million and SG&A expenses of $2.8 million, partially offset by a decrease in acquisition related earn-out costs of $1.8 million associated with the Zettlex acquisition. 41 Unallocated Corporate and Shared Services Unallocated corporate and shared services costs primarily represent costs of corporate and shared SG&A functions and other public company costs that are not allocated to the operating segments, including certain restructuring and most acquisition related costs. Unallocated corporate and shared services costs for 2020 decreased by $3.9 million, or 13.1%, from 2019, primarily due to a decrease in restructuring and acquisition related costs of $4.4 million. Unallocated corporate and shared services costs for 2019 increased by $1.1 million, or 3.9%, from 2018, primarily due to an increase in restructuring and acquisition related costs of $3.8 million, partially offset by a decrease in SG&A expenses of $2.6 million primarily related to lower variable compensation expense. Interest Income (Expense), Foreign Exchange Transaction Gains (Losses), and Other Income (Expense), Net The following table sets forth interest income (expense), foreign exchange transaction gains (losses), and other income (expense) for 2020, 2019 and 2018 (in thousands): 2020 2019 2018 Interest income (expense), net $ (6,564 ) $ (8,493 ) $ (9,814 ) Foreign exchange transaction gains (losses), net (942 ) (780 ) 147 Other income (expense), net 21 (243 ) (44 ) Interest Income (Expense), Net Net interest expense was $6.6 million in 2020 versus $8.5 million in 2019. The decrease in net interest expense was primarily due to a decrease in average debt levels and a decrease in the weighted average interest rate on our senior credit facilities. The weighted average interest rate on our senior credit facilities was 2.32% and 3.30% during 2020 and 2019, respectively. Included in net interest expense was non-cash interest expense of approximately $1.0 million and $1.1 million in 2020 and 2019, respectively, related to the amortization of deferred financing costs on our debt. Net interest expense was $8.5 million in 2019 versus $9.8 million in 2018. The decrease in net interest expense was primarily due to a decrease in average debt levels and a decrease in the weighted average interest rate on our senior credit facilities. The weighted average interest rate on our senior credit facilities was 3.30% and 3.53% during 2019 and 2018, respectively. Included in net interest expense was non-cash interest expense of approximately $1.1 million and $1.0 million in 2019 and 2018, respectively, related to the amortization of deferred financing costs on our debt. Foreign Exchange Transaction Gains (Losses), Net Foreign exchange transaction gains (losses), net, were $0.9 million net losses in 2020 versus $0.8 million net losses in 2019 primarily due to changes in the value of the U.S. Dollar against the British Pound and the Euro and net realized gains from foreign currency contracts. Foreign exchange transaction gains (losses), net, were $0.8 million net losses in 2019 versus $0.1 million net gains in 2018 primarily due to changes in the value of the U.S. Dollar against the British Pound and the Euro, and net realized gains from foreign currency contracts. Other Income (Expense), Net Net other expense was nominal in 2020, 2019 and 2018, respectively. Income Tax Provision We recorded a tax provision of $3.9 million in 2020, compared to a tax provision of $5.0 million in 2019. The effective tax rate for 2020 was 8.0% of income before income taxes, compared to an effective tax rate of 10.9% of income before income taxes for 2019. Our effective tax rate for 2020 differed from the Canadian statutory rate of 29.0% primarily due to the mix of income earned in jurisdictions with varying tax rates, $1.3 million benefit from U.K. patent box deductions, $2.3 million benefit from share-based compensation, $0.7 million reversal of valuation allowance recorded on net operating losses and other timing items in certain tax jurisdictions due to current and forecasted taxable income, $2.0 million of R&D and other tax credits, $1.1 million of estimated deductions for foreign derived intangible income, and $1.5 million benefit from the reduction in fair value of non-deductible 42 acquisition contingent consideration liabilities, offset by miscellaneous other items such as foreign withholding taxes and impact of changes in statutory tax rates on our deferred tax attributes . We recorded a tax provision of $5.0 million in 2019, compared to a tax provision of $10.2 million in 2018. The effective tax rate for 2019 was 10.9% of income before income taxes, compared to an effective tax rate of 16.7% of income before income taxes for 2018. Our effective tax rate for 2019 differed from the Canadian statutory rate of 29.0% primarily due to the mix of income earned in jurisdictions with varying tax rates, a $2.0 million benefit from U.K. patent box deductions, a $1.7 million benefit from share-based compensation, $1.5 million of other tax credits, and $0.8 million of estimated deductions for foreign derived intangible income; offset by $0.3 million of non-deductible expenses recognized under earn-out agreements in connection with various acquisitions and $0.2 million of non-deductible acquisition costs. On March 27, 2020, the U.S. federal government enacted the CARES Act in response to the COVID-19 pandemic. The CARES Act is an emergency economic stimulus package which, among other things, contains numerous provisions concerning income taxes. The CARES Act will not have a material impact on our income taxes or related disclosures. 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 acquisitions. We may seek to raise additional capital, which could be in the form of bonds, convertible debt or 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. 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, a decrease in demand for our products, our ability to integrate current and future acquisitions, deterioration in certain financial ratios, availability of borrowings under our revolving credit facility, and market changes in general. See “Risks Relating to Our Common Shares and Our Capital Structure” included in Item 1A of this Annual Report on Form 10-K. Our ability to make payments on our indebtedness and to fund our operations may be dependent upon the 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 December 31, 2020, $92.1 million of our $125.1 million cash and cash equivalents was held by our subsidiaries outside of Canada and the United States. 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 $185.8 million of our outstanding borrowings under our senior credit facilities were held in our subsidiaries outside of Canada and the United States. Additionally, we may use intercompany loans to address short-term cash flow needs for various subsidiaries. We are deferring certain U.S. payroll tax payments in 2020 in accordance with relief provisions under the CARES Act. As of December 31, 2020, we deferred $2.8 million in certain U.S. payroll tax payments under the CARES Act. As permitted under the CARES Act, we expect to pay half of the deferred U.S. payroll taxes by December 31, 2021 and the remaining half by December 31, 2022. In addition, with respect to the COVID-19 pandemic impact on liquidity, we have taken actions to reduce costs and cash expenditures across the Company. These included reducing hiring activities, restricting travel, adjusting employee compensation by eliminating fiscal year 2020 cash bonuses and base salary increases, implementing an unpaid time-off program for substantially all of our non-production workforce, limiting discretionary spending, reducing or deferring spending on capital investment projects, and deferring lease payments on certain facilities. 43 Share Repurchase P lan s 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 2020, we repurchased 65 thousand shares for an aggregate purchase price of $5.5 million at an average price of $84.52 per share under the 2018 Repurchase Plan. We had $9.5 million available for share repurchases under the 2018 Repurchase Plan as of December 31, 2020. 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. We expect that share repurchases will be made under the 2020 Repurchase Plan pursuant to Rule 10b-18 under the Securities Exchange Act of 1934 after the 2018 Repurchase Plan is completed. In an effort to preserve cash in light of the economic slowdown caused by the COVID-19 pandemic, we have temporarily suspended repurchases under our share repurchase plans since April 2020. 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 mature in December 2024. 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 make payments to pay down our revolving credit facility with cash on hand and cash generated from future operations at anytime until maturity. On March 27, 2020, we entered into the First Amendment to the Third Amended and Restated Credit Agreement and exercised a portion of the uncommitted accordion feature. The First Amendment increased the revolving credit facility commitment under the Third Amended and Restated Credit Agreement by $145.0 million, from $350.0 million to $495.0 million, and reset the uncommitted accordion feature to $200.0 million for potential future expansion. On June 2, 2020, we entered into the Second Amendment to the Third Amended and Restated Credit Agreement. The Second Amendment revised our consolidated leverage ratio definition (as defined in the Third amended and Restated Credit Agreement) allowing for the use of up to $25 million unrestricted cash and cash equivalents as a reduction to consolidated funded indebtedness (as defined in the Third amended and Restated Credit Agreement). As of December 31, 2020, we had $105.1 (€85.7) million term loan and $99.8 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 Third Amended and Restated Credit Agreement, plus a margin ranging between 0.25% to 1.25% per annum, determined by reference to our consolidated leverage ratio, or (b) the Eurocurrency Rate, as defined in the Third Amended and Restated Credit Agreement, plus a margin ranging between 1.25% and 2.25% 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 0.40% per annum, determined by reference to our consolidated leverage ratio. As of December 31, 2020, we had outstanding borrowings under the Third Amended and Restated Credit Agreement denominated in Euro and U.S. Dollars of $185.8 million and $19.0 million, respectively. 44 The Third Amended and Restated Credit Agreement contains various covenants that , we believe , are usual and customary for this type of agreement, including a maximum allowed leverage ratio and a minimum required fixed charge coverage ratio (as defined in the Third Amended and Restated Credit Agreement). The following table summarizes these financial covenants and our compliance therewith as of December 31, 20 20 : Requirement Actual December 31, 2020 Maximum consolidated leverage ratio 3.50 1.49 Minimum consolidated fixed charge coverage ratio 1.50 10.57 In addition, the Third Amended and Restated Credit Agreement contains various other customary representations, warranties and covenants applicable to the Company and its subsidiaries, including: (i) limitations on certain payments; (ii) limitations on fundamental changes involving the Company; (iii) limitations on the disposition of assets; and (iv) limitations on indebtedness, investments, and liens. Cash Flows Cash and cash equivalents totaled $125.1 million at December 31, 2020, versus $78.9 million at December 31, 2019. The net increase in cash and cash equivalents is primarily attributable to cash provided by operating activities of $140.2 million offset by $35.4 million debt repayments, $31.0 million of payments of deferred and escrowed purchase price related to prior year acquisitions, $10.5 million capital expenditures, $8.6 million of payroll tax payments upon vesting of share-based compensation awards, and $5.5 million of repurchases of common shares. The following table summarizes our cash and cash equivalent balances, cash flows and unused borrowing capacity available under our revolving credit facility for the years indicated (in thousands): 2020 2019 2018 Cash and cash equivalents, end of year $ 125,054 $ 78,944 $ 82,043 Net cash provided by operating activities $ 140,239 $ 63,248 $ 89,647 Net cash used in investing activities $ (13,156 ) $ (63,844 ) $ (45,590 ) Net cash provided by (used in) financing activities $ (84,357 ) $ (3,935 ) $ (60,164 ) Unused borrowing capacity available under revolving credit facility, end of year $ 395,239 $ 226,616 $ 189,942 Operating Cash Flows Cash provided by operating activities was $140.2 million in 2020, versus $63.2 million in 2019. Cash provided by operating activities increased from the prior year primarily due to working capital improvements resulting in an increase in cash inflows from reductions in accounts receivable and inventory balances, and a decrease in income tax payments. Cash provided by operating activities for 2020 was positively impacted by an increase in our inventory turnover ratio from 3.1 at December 31, 2019 to 3.7 at December 31, 2020 and a decrease in accounts receivable, offset by a decrease in our days payables outstanding which decreased from 53 days at December 31, 2019 to 45 days at December 31, 2020. During 2020, we paid the 2019 annual employee bonuses which had been accrued for as of December 31, 2019. Cash provided by operating activities for 2019 was negatively impacted by an increase in our days sales outstanding which increased from 51 days at December 31, 2018 to 54 days at December 31, 2019 primarily due to poor sales linearity, a decrease in our outstanding payables and accrued expenses, excluding payables and accrued expenses assumed from acquisitions in 2019, and an increase in inventories. Our inventory turnover ratio decreased from 3.4 at December 31, 2018 to 3.1 at December 31, 2019. Cash provided by operating activities for 2018 was positively impacted by an increase in our days payables outstanding and an increase in accrued expenses. The Company’s growth in revenue of $93.0 million and gross profit of $41.0 million increased our outstanding trade receivables and inventories, which negatively impacted our cash provided by operating activities. Investing Cash Flows Cash used in investing activities was $13.2 million during 2020, primarily driven by capital expenditures of $10.5 million and a payment for intangible assets of $2.6 million related to our 2016 asset acquisition of video signal processing and management technologies. 45 Cash used in investing activities was $ 63. 8 million during 201 9 , primarily related to $ 53.1 million in cash outflows ( net of cash acquired of $ 4.2 million ) related to 2019 acquisitions . We also paid $ 10. 7 million for capital expenditures during 2019. Cash used in investing activities was $45.6 million during 2018, primarily related to $29.6 million in cash outflows (net of cash acquired of $3.8 million) related to acquisitions in 2018 and $14.7 million for capital expenditures. We have no material commitments to purchase property, plant and equipment as of December 31, 2020. We expect to use approximately $21 million to $23 million in 2021 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 $84.4 million during 2020, primarily due to $35.4 million in repayments of borrowings under our Senior Credit Facilities, $31.0 million payments of deferred and escrowed purchase price related to prior year acquisitions, $8.6 million of payroll tax payments upon vesting of share-based compensation awards, $5.5 million of repurchases of common shares, and $1.6 million of fees paid in connection with the First Amendment to our Third Amended and Restated Credit Agreement. Cash used in financing activities was $3.9 million during 2019, primarily due to $50.7 million repayment of term loan and revolving credit facility borrowings, $6.9 million of payroll tax payments on share-based compensation awards, and $10.0 million of repurchases of common shares, partially offset by $66.8 million of borrowings under our revolving credit facility used to fund cash considerations paid for 2019 acquisitions. We also paid $2.7 million for debt issuance costs as a result of the Third Amended and Restated Credit Agreement entered into in December 2019. Cash used in financing activities was $60.2 million during 2018, primarily due to $30.8 million of cash consideration paid for the acquisition of the remaining equity interest in Laser Quantum Limited (“Laser Quantum”), $9.2 million of contractual term loan payments, $65.4 million of optional repayments of borrowings under our revolving credit facility, $3.6 million of payroll tax payments on share-based compensation awards, and $5.9 million of repurchases of common shares, partially offset by $55.3 million of borrowings under our revolving credit facility used to fund a portion of the cash consideration paid for the acquisition of Zettlex Holdings Limited and the remaining equity interest in Laser Quantum. In 2021, we are contractually required to pay $5.5 million in repayments under our term loan facility and $0.9 million in principal payments under our finance lease obligations. We exercised an option in December 2020 to purchase a facility for $9.2 million in Germany and expect to pay the related cash proceeds in March 2021. In addition, we may make optional repayments under our term loan and revolving credit facility from time to time with available cash generated from future operating activities. Pension Plans We maintain a defined benefit pension plan (the “U.K. Plan”) in Novanta Technologies UK Limited, a wholly owned subsidiary of the Company. Our U.K. Plan was closed to new members in 1997 and stopped accruing additional pension benefits for existing members in 2003, thereby limiting our obligation to benefits earned through that date. Benefits under this plan were based on the employees’ years of service and compensation as of the date the plan was frozen, adjusted for inflation. On July 1, 2013, the Company provided a Guarantee (the “Guarantee”) in favor of the trustees of the U.K. Plan with respect to all present and future obligations and liabilities (whether actual or contingent and whether owed jointly or severally and in any capacity whatsoever) under the U.K. Plan. Our funding policy is to fund the U.K. Plan based on actuarial methods as permitted by the Pensions Regulator in the U.K. The results of funding valuations depend on both the funding deficit and the assumptions used (such as asset returns, discount rates, mortality, retail price inflation and other market driven assumptions). Each assumption used represents one estimate of many possible future outcomes. The final cost to us will be determined by events as they actually become known, including actual return on plan assets and pension payments to plan participants. As of December 31, 2020, the projected benefit obligation under the U.K. Plan exceeded the fair value of plan assets by $1.5 million. Based on the results of the most recent funding valuation, our annual contributions are expected to be approximately $1.0 million in 2021 and will increase by 2.9% per year thereafter. Off-Balance Sheet Arrangements, Contractual Obligations Contractual Obligations The following table summarizes our contractual obligations at December 31, 2020 and the effect that such obligations are expected to have on our liquidity and cash flows in future years. We have excluded the future cash payments for unrecognized tax benefits of $5.1 million, including interest and penalties, because we are uncertain if and when such amounts may be settled. These 46 unrecognized tax benefits are further explained in Note 15 to our Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Contractual Obligations Total 2021 2022 - 2023 2024 - 2025 Thereafter (In thousands) Senior Credit Facilities (1) $ 204,840 $ 5,545 $ 11,090 $ 188,205 $ — Interest on Senior Credit Facilities (2) 15,389 4,050 7,851 3,488 — Finance leases (3) 17,292 10,060 1,837 1,908 3,487 Operating leases (4) 51,673 7,297 12,719 9,620 22,037 Purchase commitments (5) 54,568 54,416 152 — — U.K. pension plan (6) 1,511 1,013 498 — — Contingent considerations and earn-outs (7) 18,072 10,796 4,086 2,412 778 Total contractual obligations $ 363,345 $ 93,177 $ 38,233 $ 205,633 $ 26,302 (1) As of December 31, 2020, a total of $105.1 million term loan and $99.8 million revolving credit facility were outstanding under the Senior Credit Facilities. The term loan is payable in quarterly installments of approximately €1.1 million ($1.4 million) with the final installment of €68.7 million ($84.3 million) due upon maturity in December 2024. Borrowings under the revolving credit facility are due at maturity in December 2024. (2) For the purpose of this presentation, current interest rates on floating rate obligations (LIBOR plus applicable margin, as defined in the Third Amended and Restated Credit Agreement) were used for the remainder contractual life of both the term loan and outstanding borrowings under the revolving credit facility. Current commitment fee rate was used for the unused commitments under the revolving credit facility as of December 31, 2020. (3) Future minimum lease payments under finance leases include the exercise price of an option to purchase a facility for $9.2 million in Germany in 2021. The Company exercised the option in December 2020 and expects to pay the related cash proceeds in March 2021. (4) These amounts primarily represent the gross amounts due for leased facilities. The amounts include payments due with respect to both active operating facilities and idle facilities that have been vacated. (5) Purchase commitments represent purchase obligations as of December 31, 2020. (6) Amounts shown represent expected funding contributions to reach an actuarial funded status where the market value of plan assets equals the projected benefit obligations as reported on the Company’s consolidated balance sheet as of December 31, 2020. The Company expects to continue its annual funding contributions thereafter, increasing 2.9% annually through 2022, until the value of plan assets is sufficient to settle the benefit obligations under the U.K. Plan in full. (7) These amounts represent the estimated contingent consideration and earn-out payments accrued in the consolidated balance sheet as of December 31, 2020 that are expected to be paid between 2021 and 2027. The undiscounted range of the possible contingent consideration and earn-out payments is $2.7 million to $32.9 million. Off-Balance Sheet Arrangements Through December 31, 2020, we have not entered into any off-balance sheet arrangements or material transactions with unconsolidated entities or other persons. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the dates of the financial statements and the reported amounts of revenues and expenses for the reporting periods. On an ongoing basis, we evaluate our estimates, assumptions and judgments, including those related to revenue recognition, inventory valuation, impairment assessment and valuation of goodwill, intangible assets and tangible long-lived assets, valuation of contingent consideration obligations, accounting for income taxes, and accounting for loss contingencies. Actual results in the future could differ significantly from our estimates. We believe that the following critical accounting policies and estimates most significantly affect the portrayal of our financial condition and results of operations and require the most difficult and subjective judgments. Revenue Recognition. Beginning January 1, 2018, we adopted Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09” or “Topic 606”) using the modified retrospective method. Under Topic 606, an entity 47 recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. R evenue recognition for arrangements within the scope of Topic 606 includes the following five steps: ( i ) identify ing the contract(s) with a customer; (ii) identify ing the performance obligations in the contract; (iii) determin ing the transaction price; (iv) allocat ing the transaction price to the performance obligations in the contract; and (v) recogniz ing revenue when (or as) a performance obligation is satisfied . We recognize revenue when control of promised goods or services is transferred to customers. This generally occurs upon shipment when the title and risk of loss pass to the customer. The vast majority of our revenue is generated from the sale of distinct products. Revenue is measured as the amount of consideration we expect to receive in exchange for such products, which is generally at contractually stated prices. Sales taxes and value added taxes collected concurrently with revenue generating activities are excluded from revenue. Substantially all of our revenue is recognized at a point in time, upon shipment, rather than over time. At the request of our customers, we may perform professional services, generally for the maintenance and repair of products previously sold to those customers and for engineering services. Professional services are typically short in duration, mostly less than one month, and total less than 3% of our consolidated revenue. Revenue is typically recognized at a point in time when control transfers to the customer upon completion of professional services. These services generally involve a single distinct performance obligation. The consideration expected to be received in exchange for such services is normally the contractually stated amount. We occasionally sell separately priced non-standard/extended warranty services or preventative maintenance plans with the sale of products. The transfer of control over the service plans is over time. We recognize the related revenue ratably over the terms of the service plans. The transaction price of a contract is allocated to each performance obligation based on its relative standalone selling price. Standalone selling prices are generally determined based on the prices charged to customers or using the expected cost plus a margin. We account for shipping and handling activities that occur after the transfer of control over the related goods as fulfillment activities rather than performance obligations. The shipping and handling fees charged to customers are recognized as revenue and the related costs are recorded in cost of revenue at the time of transfer of control. We generally provide warranties for our products. The standard warranty period is typically 12 months to 24 months for our Photonics and Precision Motion segments and 12 months to 36 months for the Vision segment. The standard warranty period for product sales is accounted for under the provisions of ASC 450, “Contingencies,” as we have the ability to ascertain the likelihood of the liability and can reasonably estimate the amount of the liability. A provision for the estimated cost related to warranty is recorded to cost of revenue at the time revenue is recognized. Our estimate of the costs to service warranty obligations is based on historical experience and expectations of future conditions. To the extent our experience in warranty claims or costs associated with servicing those claims differ from the original estimates, revisions to the estimated warranty liability are recorded at that time, with an offsetting entry recorded to cost of revenue. We expense incremental direct costs of obtaining a contract when incurred if the expected amortization period is one year or less. These costs are recorded within selling, general and administrative expenses in the consolidated statement of operations. We do not adjust the promised amount of consideration for the effects of a financing component because the time period between the transfer of a promised good to a customer and the customer’s payment for that good is typically one year or less. Inventories . Inventories, which include materials and conversion costs, are stated at the lower of cost or net realizable value, using the first-in, first-out method. Cost includes the cost of purchased materials, inbound freight charges, customs duties and trade tariffs on imported materials and components, external and internal processing and applicable labor and overhead costs. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. We regularly review inventory quantities on hand and, when necessary, record provisions for excess and obsolete inventory based on either our forecasted product demand and production requirements or trailing historical usage of the product. If our sales do not materialize as planned or at historical levels, we may have to increase our reserve for excess and obsolete inventory, which would reduce our earnings. If actual market conditions are more favorable than anticipated, inventory previously written down may be sold, resulting in lower cost of revenue and higher income from operations than expected in that period. Share-Based Compensation. We record expenses associated with share-based compensation awards to employees and directors based on the fair value of awards as of the grant date. For share-based compensation awards that vest over time based on employment, the associated expenses are recognized in the consolidated statement of operations ratably over the vesting period of the award, net of estimated forfeitures. 48 We typically grant two types of performance-based awards to certain members of the executive management team: non-GAAP EPS performance-based restricted stock units (“EPS-PSUs”) and relative total shareholder return performance-based restricted stock units (“TSR-PSUs”). For EPS-PSUs, share-based compensation expense is recognized ratably over the vesting period when it is probable that specified performance targets are expected to be achieved based on management’s projections. Management’s projections are revised, if necessary, in subsequent periods when underlying factors change the evaluation of the probability of achieving the performance targets as well as the level of achievement . When the estimated achievement levels are adjusted at a later date, a cumulative adjustment to the share-based compensation expense previously recognized would be required. Accordingly, share-based compensation expense associated with EPS-PSUs may differ significantly from period to period based on changes to both the probability and the level of achievement against performance targets. For TSR-PSUs, we recognize the related compensation expense based on the fair value of the TSR-PSUs, which is determined using the Monte-Carlo simulation valuation model as of the date of grant. The expense related to TSR-PSUs is recognized on a straight-line basis from the grant date to the end of the performance period, which is generally three years , regardless of whether the target relative total s hare holder return is achieved . The Monte Carlo simulation model utilizes multiple input variables that determine the probability of satisfying the performance conditions stipulated in the grant agreement in a large number of simulated scenarios. Key assumptions for the Monte Carlo simulation model include risk-free interest rate and expected stock price volatility of both the Company’s common shares and the Russell 2000 index. Valuation of Long-lived Assets. The purchase price we pay for acquired companies is allocated first to the identifiable assets acquired and liabilities assumed at their fair value. Any excess purchase price is then allocated to goodwill. We make various assumptions and estimates in order to assign fair value to acquired tangible and intangible assets and liabilities. Key assumptions typically include revenue growth rates and projected cash flows, discount rates, royalty rates, technology obsolescence curves, and customer attrition rates, among others. Actual cash flows may vary from forecasts used to value these assets at the time of the business combination. Our most significant identifiable intangible assets are customer relationships, acquired technologies, trademarks and trade names. In addition to our review of the carrying value of each asset, the useful life assumption for each asset, including the classification of certain intangible assets as “indefinite-lived,” are reviewed on a periodic basis to determine if changes in circumstances warrant revisions to them. All definite-lived intangible assets are amortized over the periods in which their economic benefits are expected to be realized. Impairment analyses of goodwill and indefinite-lived intangible assets are conducted in accordance with ASC 350, “Intangibles—Goodwill and Other.” We test our goodwill balances annually as of the beginning of the second quarter or more frequently if indicators are present, or changes in circumstances suggest, that an impairment may exist. Should the fair value of our goodwill or indefinite-lived intangible assets decline because of reduced operating performance, market declines or other indicators of impairment, or as a result of changes in the discount rate, charges for impairment loss may be necessary. We evaluate our goodwill, intangible assets and other long-lived assets for impairment at the reporting unit level which is generally at least one level below our reportable segments. We have the option of first performing a qualitative assessment to determine whether it is necessary to perform the quantitative impairment test. In performing the qualitative assessment, we review factors both specific to the reporting unit and to the Company as a whole, such as financial performance, macroeconomic conditions, industry and market considerations, and the fair value of each reporting unit as of the last valuation date. If we elect this option and believe, as a result of the qualitative assessment, that it is more likely than not that the carrying value of goodwill is not recoverable, the quantitative impairment test is required; otherwise, no further testing is required. Alternatively, we may elect to bypass the qualitative assessment and perform the quantitative impairment test instead. This approach requires a comparison of the carrying value of each of our reporting units to the fair value of these reporting units. If the carrying value of a reporting unit exceeds its fair value, an impairment charge is recorded for the difference. The fair value of a reporting unit is estimated primarily using a discounted cash flow (“DCF”) method. The DCF approach requires that we forecast future cash flows for each of the reporting units and discount the cash flow streams based on a weighted average cost of capital (“WACC”) that is derived, in part, from comparable companies within similar industries. The DCF calculations also include a terminal value calculation that is based upon an expected long-term growth rate for the applicable reporting unit. The carrying values of each reporting unit include assets and liabilities which relate to the reporting unit’s operations. Additionally, reporting units that benefit from corporate assets or liabilities are allocated a portion of those corporate assets and liabilities on a proportional basis. We assess indefinite-lived intangible assets for impairment on an annual basis, and more frequently if impairment indicators are identified. We also periodically reassess their continuing classification as indefinite-lived intangible assets. Impairment exists if the fair value of the intangible asset is less than its carrying value. An impairment charge equal to the difference is recorded to reduce the carrying value to its fair value. 49 We evaluate amortizable intangible assets and other long-lived assets for impairment in accordance with ASC 360-10-35-15, “Impairment or Disposal of Long-Lived Assets,” whenever changes in events or circumstances indicate that the carrying values of the reporting units may exceed the undiscounted cash flow forecasts attributable to the reporting units. If undiscounted cash flow forecasts indicate that the carrying value of definite-lived intangible asset s or other long-lived asset s may not be recoverable, a fair value assessment is performed. For intangible assets, fair value estimates are derived from discounted cash flow forecasts. For other long-lived assets (primarily property, plant and equipment), fair value estimates are derived from the sources most appropriate for the particular asset and have historically included such approaches as sales comparison approach and replacement cost approach. If fair value is less than carrying value, an impairment charge equal to the difference is recorded. We also review the useful life and residual value assumptions for definite-lived intangible assets and other long-lived assets on a periodic basis to determine if changes in circumstances warrant revisions to them. Factors which may trigger an impairment of our goodwill, intangible assets and other long-lived assets include the following: • significant underperformance relative to historical or projected future operating results; • changes in our use of the acquired assets or the strategy for our overall business; • long-term negative industry or economic trends; • technological changes or developments; • changes in competition; • loss of key customers or personnel; • adverse judicial or legislative outcomes or political developments; • significant declines in our stock price for a sustained period of time; and • the decline of our market capitalization below net book value as of the end of any reporting period. The occurrence of any of these events or any other unforeseeable events or circumstances that materially affect future operating results or cash flows may cause an impairment that is material to our results of operations or financial position in the reporting period in which it occurs or is identified. The most recent annual goodwill and indefinite-lived intangible asset impairment test was performed as of the beginning of the second quarter of 2020, using a quantitative assessment, noting no impairment. As of December 31, 2020, there were no indicators of impairment of our long-lived assets. We have a significant amount of goodwill, intangible assets and other long-lived assets. The following table shows the breakdown of goodwill, intangible assets and property, plant and equipment by reportable segment as of December 31, 2020 (in thousands): Goodwill Intangible Assets, net Property, Plant & Equipment, net Photonics $ 116,056 $ 59,900 $ 32,449 Vision 133,473 69,253 33,181 Precision Motion 36,451 19,368 8,762 Unallocated Corporate and Shared Services — — 4,284 Total $ 285,980 $ 148,521 $ 78,676 Contingent Consideration. We record contingent consideration resulting from a business combination at its fair value on the acquisition date. Key assumptions used in the determination of the fair value of the contingent consideration include the following: • future revenue projections; • volatility of future revenue; and • discount rates used to present value the projected cash flows. On a quarterly basis, we revalue these assumptions and record the necessary adjustments to fair value in the consolidated statement of operations. Changes to contingent consideration obligation can result from adjustments to future revenue projections, volatility of future revenue and discount rates. 50 The assumptions used for the determin ation of the fair value of contingent consideration s include a significant amount of judgment, and changes in the underlying estimates could have a material impact on the amount of contingent consideration expense recorded in any given period. Accounting for Income Taxes . As part of the process of preparing our consolidated financial statements, we are required to calculate our income tax provision (benefit) in each of the jurisdictions in which we operate. This process involves estimating our current income tax provision (benefit) together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are reported on our consolidated balance sheet. Judgment is required in determining our worldwide income tax provision. In the ordinary course of a global business, there are many transactions and calculations where the ultimate outcome is uncertain. Although we believe our estimates are reasonable, there is no assurance that the final outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. Such differences could have a material impact on our income tax provision and net income in the period in which such determination is made. We record a valuation allowance on our deferred tax assets when it is more likely than not that they will not be realized. We have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. In the event we determine that we are able to realize our deferred tax assets in the future in excess of their net recorded amount, an adjustment to the valuation allowance for the deferred tax assets would be recorded and would increase our net income in the period in which such determination is made. Likewise, should we determine that we will not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the valuation allowance for the deferred tax assets will be recorded and will reduce our net income in the period such determination is made. In conjunction with our ongoing review of our actual results and anticipated future earnings, we continuously reassess the adequacy of the valuation allowance currently in place on our deferred tax assets. In 2020, we reversed valuation allowance of $0.7 million recorded on net operating losses and other timing items in certain tax jurisdictions due to current and forecasted taxable income. The amount of income taxes we pay is subject to audits by federal, state and foreign tax authorities, which may result in proposed assessments. We believe that we have adequately provided for any reasonably foreseeable outcome related to these matters. However, our future results may include favorable or unfavorable adjustments to our tax liabilities in the period that the assessments are made or resolved, or when the statute of limitations for certain periods expires. As of December 31, 2020, the total amount of gross unrecognized tax benefits was $5.3 million, of which $5.0 million would favorably affect our effective tax rate, if recognized. Over the next twelve months, we may need to recognize up to $0.5 million of previously unrecognized tax benefits in the event of statute of limitations closures. Income and foreign withholding taxes have not been recognized on the excess of the amount for financial reporting purposes over the tax basis of investments in foreign subsidiaries that are essentially permanent in nature. This amount becomes taxable upon a repatriation of assets from a subsidiary or a sale or liquidation of a subsidiary. The amount of undistributed earnings of foreign subsidiaries totaled $220.4 million as of December 31, 2020. The estimated unrecognized income and foreign withholding tax liabilities on this temporary difference is approximately $3.9 million. Loss Contingencies. We are subject to legal proceedings, lawsuits and other claims relating to product quality, labor, service and other matters arising in the ordinary course of business. We review the status of each significant matter and assess our potential financial exposure on a quarterly basis. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of uncertainties related to these matters, accruals are based only on the best information available as of the date of the financial statement. As additional information becomes available, we will reassess the potential liability related to our pending claims and litigation and may revise our estimates. Such revisions in the estimates of the potential liabilities could have a material impact on our results of operations and financial position. We expense legal fees as incurred. Recent Accounting Pronouncements See Note 2 to Consolidated Financial Statements for recent accounting pronouncements that could have an effect on us. 51