Avantor, Inc. (AVTR) FY 2022 MD&A

Item 7.    Management’s discussion and analysis of financial condition and results of operations

This discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results may differ materially from those contained in or implied by any forward-looking statements. See “Cautionary factors regarding forward-looking statements.”

Overview

For the fiscal year ended December 31, 2022, we recorded net sales of $7,512.4 million, net income of $686.5 million and Adjusted EBITDA of $1,570.7 million. We also generated net sales growth of 1.7% which included 2.4% organic growth compared to the same period in 2021. See “Reconciliations of non-GAAP measures” for a reconciliation of net income to Adjusted EBITDA and “Results of operations” for a reconciliation of net sales growth to organic net sales growth.

Trends affecting our business and results of operations

The following trends have affected our recent operating results, and they may also continue to affect our performance and financial condition in future periods.

Our results are being impacted by the ongoing global coronavirus outbreak

The COVID-19 pandemic continues to effect global economies, financial markets and the overall environment in which we do business as further described in Part I, Item 1A, “Risk factors.” The outbreak continued to impact the full year results of our three segments, as described further in the “Results of operations” section.

We completed acquisitions to further enhance our business model

We completed the acquisitions of Masterflex, Ritter GmbH, and RIM Bio in 2021. Masterflex is a leading global manufacturer of peristaltic pumps and aseptic single-use fluid transfer technologies. Ritter GmbH is focused on supplying high-quality liquid handling consumables used in a variety of molecular screening and diagnostic applications and as part of drug discovery and clinical trial testing in pharma and biotech applications and cartridges for sealants, adhesives and inks that are used in a variety of industrial applications. RIM Bio provides a complete range of single-use 2D bags, 3D bags, tank liners, bag assemblies and multi-bag manifolds used in the manufacturing of biologics including monoclonal antibodies (mAbs), vaccines, cell and gene therapies, and recombinant proteins.

Ritter’s revenues declined in 2022 compared to prior expectations, primarily from reduced customer demand for medical fluid handling tips due to a decrease in COVID-19 testing. We are taking measures to replace these revenues; however, if these measures are not successful, we may be required to impair Ritter’s long-lived assets. The total carrying value of Ritter’s net assets, excluding goodwill, which is part of our Europe reporting unit, was $247.0 million as of December 31, 2022, including $164.7 million of finite-lived intangible assets and $129.2 million of property, plant & equipment.

We have been impacted by supply chain constraints and inflationary pressures

We have experienced challenges in sourcing certain products and raw materials as a result of global supply chain disruptions and have experienced inflationary pressures across all of our cost categories.

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While we have implemented pricing and productivity measures to combat these pressures, they may continue to adversely impact our results.

We lowered our weighted average annual cost of interest and simplified our capital structure

In 2022, we amended our receivables facility to increase its funding limit up to $400.0 million and extended the term to October 27, 2025. Also, we fully repaid U.S. dollar term loan B-4, Euro term loan B-3 and made a total prepayment of $555.0 million on U.S. dollar term loan B-5 which resulted in reduction of our annual cost of interest. To protect against rising interest rates, we entered into an interest rate swap and a cross currency swap that collectively convert interest payments on $750.0 million of our U.S. dollar term loan from U.S. dollar variable-rate to a Euro fixed-rate.

In 2021, we issued $396.5 million and $738.1 million of term loans that mature on June 9, 2026 and June 9, 2028, respectively. The debt bears interest at variable rates. We also issued $800.0 million aggregate principal amount of 3.875% senior unsecured notes. The notes are due on November 1, 2029, with interest payable semi-annually on May 1 and November 1 of each year. Additionally, we also amended our senior secured credit facilities and issued $900.0 million of incremental U.S. dollar term loan at LIBOR plus 2.25%.

We reduced our expenses through a global restructuring program

Under a global restructuring program, which concluded on December 31, 2020, we combined sales and marketing resources, eliminated redundant corporate functions, optimized procurement and our manufacturing footprint, and implemented best practices throughout the organization.

From inception of the program through its completion on December 31, 2020, we have recognized $129.8 million of charges and have spent $9.6 million on capital projects, the vast majority of these expenses were incurred through 2020 with an immaterial amount incurred in 2021 and 2022. Through December 31, 2020, we believe that we have generated over $220.0 million of annualized cost synergies, which we believe will favorably impact our results in 2023 and beyond. The program was originally envisioned to last for three years following the VWR acquisition and has concluded.

We are investing in a differentiated innovation model

We are engaging with our customers early in their product development cycles to advance their programs from research and discovery through development and commercialization. These projects include enhancing product purity and performance characteristics, improving product packaging and streamlining workflows. We are also developing new products in emerging areas of science such as cell and gene therapy.

Changes in foreign currency exchange rates are impacting our financial condition and results of operations

Our consolidated results of operations are comprised of many different functional currencies that translate into our U.S. dollar reporting currency. The movement of the U.S. dollar against those functional currencies, particularly the Euro, has caused significant variability in our results and may continue to do so in the future. See Item 7A, “Quantitative and qualitative disclosures about market risk.”

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Key indicators of performance and financial condition

To evaluate our performance, we monitor a number of key indicators. As appropriate, we supplement our results of operations determined in accordance with GAAP with certain non-GAAP measures that we believe are useful to investors, creditors and others in assessing our performance. These measurements should not be considered in isolation or as a substitute for reported GAAP results because they may include or exclude certain items as compared to similar GAAP-based measurements, and such measurements may not be comparable to similarly-titled measurements reported by other companies. Rather, these measurements should be considered as an additional way of viewing aspects of our operations that provide a more complete understanding of our business.

The key indicators that we monitor are as follows:

•Net sales, gross margin, operating income and net income or loss. These measures are discussed in the section entitled “Results of operations”;

•Organic net sales growth, which is a non-GAAP measure discussed in the section entitled “Results of operations.” Organic net sales growth eliminates from our reported net sales the impacts of earnings from any acquired or disposed businesses and changes in foreign currency exchange rates. We believe that this measurement is useful to investors as a way to measure and evaluate our underlying commercial operating performance consistently across our segments and the periods presented. This measurement is used by our management for the same reason. Reconciliations to the change in reported net sales, the most directly comparable GAAP financial measure, are included in the section entitled “Results of operations”;

•Adjusted EBITDA and Adjusted EBITDA margin, which are non-GAAP measures discussed in the section entitled “Results of operations.” Adjusted EBITDA is used by investors to measure and evaluate our operating performance exclusive of interest expense, income tax expense, depreciation, amortization and certain other adjustments. Adjusted EBITDA margin is Adjusted EBITDA divided by net sales as determined under GAAP. We believe that these measurements are useful to investors as a way to analyze the underlying trends in our business consistently across the periods presented. A reconciliation of net income or loss, the most directly comparable GAAP financial measure, to Adjusted EBITDA is included in the section entitled “Reconciliations of non-GAAP measures”;

•Cash flows from operating activities, which is discussed in the section entitled “Liquidity and capital resources—Historical cash flows”; and

•Free cash flow, which is a non-GAAP measure, is equal to our cash flow from operating activities, plus acquisition-related costs paid in the period, less capital expenditures. We believe that this measurement is useful to investors as it provides a view on the Company’s ability to generate cash for use in financing or investing activities. This measurement is used by management for the same reason. A reconciliation of cash flows from operating activities, the most directly comparable GAAP financial measure, to free cash flows, is included in the section entitled “Liquidity and capital resources—Historical cash flows.”

Results of operations

We present results of operations in the same way that we manage our business, evaluate our performance and allocate our resources. We also provide discussion of net sales and Adjusted EBITDA by geographic

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segment based on customer location: the Americas, Europe and AMEA. Corporate costs are managed on a standalone basis and not allocated to segments.

Years ended December 31, 2022 and 2021

Executive summary

Net sales growth was driven by our biopharma and advanced technologies & applied materials end markets, as well as the impact of all the acquisitions that we completed in the prior year, partially offset by unfavorable foreign currency impact and COVID-19 related headwinds. Commercial excellence, growth of our proprietary materials and consumables product group and sales of higher-margin products, including those offered by recently acquired companies contributed to expansion in both gross margin and Adjusted EBITDA margin.

Net sales

Net sales increased $126.3 million or 1.7%, which included $317.1 million or 4.3% of unfavorable foreign currency impact and $268.2 million or 3.6% of M&A impact. Organic growth was $175.2 million or 2.4% (6.0% when excluding the impact of sales of COVID-19-related products in both periods, referred to herein as COVID-19 related headwinds or tailwinds) and was primarily due to growth in our proprietary products and services.

In the Americas, net sales increased $233.8 million or 5.5%, which included $14.1 million or 0.3% of unfavorable foreign currency impact and $133.1 million or 3.1% of M&A impact. Organic growth in net sales was $114.8 million or 2.7% (6.1% excluding COVID-19 headwinds). Additional information on

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organic net sales growth by end market (with approximate percentage of total organic net sales for the region) is as follows:

•Biopharma (55%) — Sales grew low single-digits, primarily due to growth in sales of proprietary materials in biopharma production driven by our chemicals and serum product offerings, partially offset by reduced sales of COVID-19 related offerings for vaccines, PPE and diagnostic testing.

•Healthcare (10%) — Sales were flat as growth in our medical grade silicone business was offset by declines in COVID-19 related offerings for diagnostic testing.

•Education and government (15%) — Sales declined mid single-digits primarily driven by softness in lab consumables sales in the education end market and COVID-19 related headwinds in the government end market.

•Advanced technologies & applied materials (20%) — Sales increased high single-digits driven by strong sales to our semiconductor and electronic device customers.

In Europe, net sales decreased $160.8 million or 6.0%, which included $276.4 million or 10.3% of unfavorable foreign currency impact and $92.0 million or 3.4% of M&A impact. Organic net sales growth was $23.6 million or 0.9% (5.5% excluding COVID-19 headwinds). Additional information on organic net sales growth by end market (with approximate percentage of total organic net sales for the region) is as follows:

•Biopharma (50%) — Sales grew low single-digits driven by double-digit growth in our production chemicals and single-use offerings, partially offset by lower sales of COVID-19 related offerings for vaccines, PPE and diagnostic testing.

•Healthcare (10%) — Sales declined low single-digits as growth in our medical grade silicone business was more than offset by declines in COVID-19 related offerings for diagnostic testing.

•Education & government (10%) — Sales declined mid single-digits driven by decreased sales of lab chemicals and consumables in the education end market and from COVID-19 related headwinds in the government end market.

▪Advanced technologies & applied materials (30%) — We experienced low single-digit growth driven by increased sales of proprietary materials and consumables, and equipment and instrumentation.

In AMEA, net sales increased $53.3 million or 11.3%, which included $26.6 million or 5.6% of unfavorable foreign currency impact and $43.1 million or 9.1% of M&A impact. Organic net sales growth was $36.8 million or 7.8% (7.0% excluding COVID-19 tailwinds). Additional information on organic net sales growth by end market (with approximate percentage of total organic net sales for the region) is as follows:

•Biopharma (50%) — Sales declined by mid single-digits as double-digit growth in process ingredients, chromatography resins, excipients and single use solutions was offset by lower sales of COVID-19 related offerings for vaccines and PPE and lower lab consumable sales.

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•Advanced technologies & applied materials (40%) — Sales grew double-digits primarily driven by strong demand for our proprietary offerings into the semiconductor industry.

Gross margin

Gross margin increased 70 basis points resulting primarily from commercial excellence and favorable product mix in our proprietary materials business, as well as a favorable impact from sales of higher gross margin products from acquired companies.

Operating income

Operating income increased primarily from higher gross profit, as previously discussed, as well as the absence of acquisition costs incurred in the prior year and lower incentive compensation expense. This was partially offset by higher amortization expense driven by the completion of our acquisitions in the prior year as well as inflation and investments in our workforce made over the course of 2021 and into 2022.

Net income

Net income increased due to higher operating income, as previously discussed, and lower income tax expense driven primarily from the favorable resolution of uncertain tax positions and lower effective tax rates in the European region in the current year. These increases were partially offset by higher interest expense as a result of incremental debt issued to finance the acquisitions completed in 2021, increased interest rates, and the absence of a one-time disgorgement penalty payment that we received in 2021.

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Adjusted EBITDA

For reconciliations of Adjusted EBITDA to net income or loss, see “Reconciliations of non-GAAP measures.”

Adjusted EBITDA increased $112.1 million or 7.7%, which included an unfavorable foreign currency translation impact of $60.5 million or 4.1% and $99.5 million or 6.8% from M&A. The remaining growth was $73.1 million or 5.0%.

In the Americas, Adjusted EBITDA grew $98.9 million or 10.1%, or 4.3% when adjusted for unfavorable foreign currency translation impact and M&A. Higher gross profit from commercial excellence and favorable product mix related to sales of our higher-margin proprietary products was partially offset by inflationary factors, including freight, and investments in our workforce made over the course of 2021 and into 2022.

In Europe, Adjusted EBITDA declined $14.4 million or 2.7%, but grew 2.5% when adjusted for unfavorable foreign currency translation impact and M&A. The growth was driven primarily by higher gross profit from favorable product mix. This was partially offset by inflationary factors and investments in our workforce made over the course of 2021 and into 2022.

In AMEA, Adjusted EBITDA grew $27.6 million or 24.2%, or 14.8% when adjusted for unfavorable foreign currency translation impact and M&A. Increases driven by higher gross profit were partially offset by inflationary factors, including freight.

In Corporate, Adjusted EBITDA was flat year over year and did not materially contribute to the change in Adjusted EBITDA.

Year ended December 31, 2020

A discussion and analysis covering the year ended December 31, 2020 is included in our 2021 10-K.

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Reconciliations of non-GAAP measures

The following table presents the reconciliation of net income or loss to non-GAAP measures:

1.Represents legal, accounting, investment banking and consulting fees incurred related to the acquisition of acquired companies.

2.Represents non-recurring direct costs incurred with third parties to integrate acquired companies. These expenses represent incremental costs and are unrelated to normal operations of our business. Integration expenses are incurred over a pre-defined integration period specific to each acquisition.

3.Represents the non-cash reduction of contingent consideration related to the Ritter acquisition and the amortization of the purchase accounting adjustment to record inventory acquired from Masterflex and Ritter at fair value.

4.Reflects the incremental expenses incurred in the period related to initiatives to increase profitability and productivity. Typical costs included in this caption are employee severance, site-related exit costs, and contract termination costs.

5.As described in note 19 to our consolidated financial statements beginning on F-1 of this report.

Liquidity and capital resources

We fund short-term cash requirements primarily from operating cash flows, while most of our long-term financing is from indebtedness, which we use to finance transactions outside of our normal operations.

Our most significant contractual obligations are scheduled principal and interest payments for indebtedness. We also have obligations to make payments under operating leases, to purchase certain products and services and to fund defined benefit plan obligations primarily outside of the United States. In addition to contractual obligations, we use cash to fund capital expenditures, taxes, and dividends on our MCPS for which the last payment was made in May 2022. Changes in working capital may be a source or a use of cash depending on our operations during the period.

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We expect to fund our short-term and long-term capital needs with cash generated by operations and availability under our credit facilities. Although we believe that these sources will provide sufficient liquidity for us to meet our long-term capital needs, our ability to fund these needs will depend to a significant extent on our future financial performance, which will be subject in part to general economic, competitive, financial, regulatory and other factors that are beyond our control.

We believe that cash generated by operations, together with available liquidity under our credit facilities, will be adequate to meet our current and expected needs for cash prior to the maturity of our debt, although no assurance can be given in this regard.

Liquidity

The following table presents our primary sources of liquidity:

Our availability under our receivables facility depends upon maintaining a sufficient borrowing base of eligible accounts receivable. We believe that we have sufficient capital resources to meet our liquidity needs.

At December 31, 2022, $349.4 million or 94% of our cash and cash equivalents was held by our non-U.S. subsidiaries and may be subject to certain taxes upon repatriation, primarily where foreign withholding taxes apply.

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Historical cash flows

The following table presents a summary of cash provided by (used in) various activities:

1.Consists of typical non-cash charges including depreciation and amortization, stock based compensation expense, deferred income tax expense and others.

2.Includes changes to our accounts receivable, inventory, contract assets and accounts payable.

Cash flows from operating activities provided $110.0 million less cash in 2022 primarily due to higher payments for interest and tax, higher incentive compensation payments made in fiscal year 2022, and higher customer prebate payments made in connection with newly signed supply agreements. This was partially offset by higher operating income and favorable changes in net working capital.

Investing activities used $4,012.1 million less cash in 2022, reflecting the cash paid for acquisitions in the previous year as well as cash received from the settlement of a cross currency swap in the third quarter of 2022. These items were offset by increased capital spending across the Company compared to the prior year.

Financing activities used $3,867.9 million more cash in 2022 compared to the prior year. In 2021, financing activities provided $3,219.2 million of cash primarily due to issuances of new debt and secondary equity offerings to finance our acquisitions. In 2022, we used $648.7 million of cash primarily to pay down our term loans.

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Free cash flow

Free cash flow was $210.1 million lower in 2022 due to changes in cash flows from operating activities noted above, as well as an increase in capital spending in 2022, principally reflecting growth-related expansions in our global supply chain.

A discussion and analysis of historical cash flows covering the year ended December 31, 2020 is included in the 2021 10-K.

Indebtedness

A significant portion of our long-term financing is from indebtedness. The purpose of this section is to disclose how certain features of our indebtedness influence our liquidity and capital resources. Additional detail about the terms of our indebtedness may be found in note 14 to our consolidated financial statements beginning on page F-1 of this report.

Our credit facilities provide us access to up to $872.7 million of additional cash.

We have entered into a receivables facility and a revolving credit facility that provide us access to cash to fund short-term business needs. See the section entitled “Liquidity” for additional information.

Our indebtedness restricts us from paying dividends to common stockholders.

The acquisition of VWR was partially funded by the issuance of debt by Avantor Inc.’s wholly-owned subsidiary, Avantor Funding, Inc. Certain of those debt agreements prevent Avantor Funding, Inc. from paying dividends or making other payments to Avantor, Inc., subject to limited exceptions. At December 31, 2022 and 2021, substantially all of Avantor, Inc.’s net assets were subject to those restrictions.

Our senior secured credit facilities require or may require us to make certain principal repayments prior to maturity

We are required to make quarterly payments on our senior secured credit facilities, with the balance due on the maturity date. We have generated sufficient cash flows to make all required historical payments, and we expect that our cash flows will continue to be sufficient to make future payments.

To the extent our net leverage ratios, as defined in our credit agreement, reach certain levels, we are required to make additional prepayments if: (i) we generate excess cash flows, as defined in our credit agreement, at specified percentages that decline if certain net leverage ratios are achieved; or (ii) we receive cash proceeds from certain types of asset sales or debt issuances. We are required to make a prepayment of 50% of our excess cash flows if our first lien net leverage ratio, as defined in our credit agreement, exceeds 4.50:1.00, a prepayment of 25% of our excess cash flows if our first lien net leverage

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ratio is less than or equal to 4.50:1.00 but greater than 3.75:1.00, and no prepayment if our first lien net leverage ratio is less than or equal to 3.75:1.00. As our first lien net leverage ratio was below 3.75:1.00 at December 31, 2022, no additional prepayments were required and no such prepayments have become due since the inception of the credit facilities.

We are subject to certain financial covenants that, if not met, could put us in default of our debt agreements

The receivables facility and our senior secured credit facilities contain certain customary covenants, including a financial covenant. That covenant becomes applicable in periods when we have drawn more than 35% of our revolving credit facility. When applicable, we may not have total borrowings in excess of a pro forma net leverage ratio, as defined. This covenant was not applicable at December 31, 2022, and our historical net leverage has been below the covenant requirement.

Contractual obligations

The following table presents our contractual obligations at December 31, 2022:

(1)Includes finance lease liabilities. To calculate payments for principal and interest, we assumed that variable interest rates, foreign currency exchange rates and outstanding borrowings under credit facilities were unchanged from December 31, 2022 through maturity. Further, we have not considered any interest obligation on our receivables facility. For the variable interest rates and principal amounts used, see note 14 to our consolidated financial statements beginning on page F-1 of this report.

(2)Our senior secured credit facilities would require us to accelerate our principal repayments should we generate excess cash flows, as defined, in future periods.

(3)Purchase obligations for certain products and services are made in the normal course of business to meet operating needs.

(4)Represents our obligation to fund defined benefit plans with obligations in excess of plan assets. The total obligation is equal to the aggregate excess of the discounted benefit obligation over the fair value of plan assets for all underfunded plans. The payments due in less than one year are estimated using actuarial methods. The payments due for all other years are estimated by distributing the remaining funding status to future periods in the same way as benefit payments are expected to be made by the plans following actuarial methods.

(5)Represents our transition tax obligation due over eight years to transition to the modified territorial tax system under new U.S. income tax legislation.

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Critical accounting policies and estimates

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported throughout the financial statements. Those estimates and assumptions are based on our best estimates and judgment. We evaluate our estimates and assumptions on an ongoing basis using historical experience and known facts and circumstances. We adjust our estimates and assumptions when we believe the facts and circumstances warrant an adjustment. As future events and their effects cannot be determined with precision, actual results could differ significantly from those estimates.

We consider the policies and estimates discussed below to be critical to an understanding of our financial statements because their application places the most significant demands on our judgment. Specific risks for these critical accounting policies are described in the following sections. For all of these policies, we caution that future events rarely develop exactly as forecasted, and such estimates naturally require adjustment.

Our discussion of critical accounting policies and estimates is intended to supplement, not duplicate, our summary of significant accounting policies so that readers will have greater insight into the uncertainties involved in these areas. For a summary of all of our significant accounting policies, see note 2 to our consolidated financial statements beginning on page F-1 of this report.

Testing goodwill and other intangible assets for impairment

We carry significant amounts of goodwill and other intangible assets on our consolidated balance sheet. At December 31, 2022, the combined carrying value of goodwill and other intangible assets, net of accumulated amortization and impairment charges, was $9,785.9 million or 73% of our total assets.

Required annual assessment

On October 1 of each year, we perform annual impairment testing of our goodwill and indefinite-lived intangible assets, or more frequently if an event or change in circumstance occurs that would require reassessment of the recoverability of those assets. The impairment analysis for goodwill and indefinite-lived intangible assets consists of an optional qualitative test potentially followed by a quantitative analysis. These measurements rely upon significant judgment from management described as follows:

•The qualitative analysis for goodwill and indefinite-lived intangible assets requires us to identify potential factors that may result in an impairment and estimate whether they would warrant performance of a quantitative test;

•The quantitative impairment test requires us to estimate the fair value of our reporting units and indefinite-lived intangible assets. We estimate the fair value of each reporting unit using a weighted average of two valuation methods based on a discounted cash flows method and a guideline public company method. These valuation methods require management to make various assumptions, including, but not limited to, future profitability, cash flows, discount rates, weighting of valuation methods and the selection of comparable publicly traded companies.

Our estimates are based on historical trends, management’s knowledge and experience and overall economic factors, including projections of future earnings potential. Developing future cash flows in applying the income approach requires us to evaluate our intermediate to longer-term strategies, including, but not limited to, estimates about net sales growth, operating margins, capital requirements,

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inflation and working capital management. The development of appropriate rates to discount the estimated future cash flows requires the selection of risk premiums, which can materially impact the present value of future cash flows. Selection of an appropriate peer group under the market approach involves judgment, and an alternative selection of guideline companies could yield materially different market multiples. Weighing the different value indications involves judgment about their relative usefulness and comparability to the reporting unit.

We did not record any impairment charges as a result of our October 1, 2022 impairment testing. Each reporting unit had a fair value that was substantially in excess of its carrying value, and our indefinite-lived intangible assets did not show any indications that their fair value was more likely than not below their carrying value.

Estimating valuation allowances on deferred tax assets

We are required to estimate the degree to which tax assets and loss carryforwards will result in a future income tax benefit, based on our expectations of future profitability by tax jurisdiction. We provide a valuation allowance for deferred tax assets that we believe will more likely than not go unutilized. If it becomes more likely than not that a deferred tax asset will be realized, we reverse the related valuation allowance and recognize an income tax benefit for the amount of the reversal. At December 31, 2022, our valuation allowance on deferred tax assets was $179.7 million, $155.0 million of which relates to foreign net operating loss carry forwards that are not expected to be realized.

We must make assumptions and judgments to estimate the amount of valuation allowance to be recorded against our deferred tax assets, which take into account current tax laws and estimates of the amount of future taxable income, if any. Changes to any of the assumptions or judgments could cause our actual income tax obligations to differ from our estimates.

Accounting for uncertain tax positions

In the ordinary course of business, there is inherent uncertainty in quantifying our income tax positions. We assess income tax positions for all years subject to examination based upon our evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where it is more likely than not that a tax benefit will be sustained, we have recorded an amount having greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority assumed to have full knowledge of all relevant information. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements. Our reserve for uncertain tax positions was $51.8 million at December 31, 2022, exclusive of penalties and interest. Where applicable, associated interest expense has also been recognized as a component of interest expense.

We operate in numerous countries under many legal forms and, as a result, we are subject to the jurisdiction of numerous domestic and non-U.S. tax authorities, as well as to tax agreements and treaties among these governments. Determination of taxable income in any jurisdiction requires the interpretation of the related tax laws and regulations and the use of estimates and assumptions regarding significant future events, such as the amount, timing and character of deductions and the sources and character of income and tax credits. Changes in tax laws, regulations, agreements and treaties, currency exchange restrictions or our level of operations or profitability in each taxing jurisdiction could have an impact upon the amount of current and deferred tax balances and hence our net income.

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We file tax returns in each tax jurisdiction that requires us to do so. Should tax return positions not be sustained upon audit, we could be required to record an income tax provision. Should previously unrecognized tax benefits ultimately be sustained, we could be required to record an income tax benefit.

Calculating expense for long-term compensation arrangements

Our employees receive various long-term compensation awards, including stock options, RSUs, performance stock units and cash-based awards. We calculate expense for some of those awards using fair value estimates based on unobservable inputs. Additionally, some of those awards contain performance or market conditions. We assess the probability of achieving those performance conditions, and in cases where partial or exceptional performance affects the size of the award, we also estimate the projected achievement level. We determine the fair value of awards with market conditions on their grant date using a Monte Carlo model, which incorporates the probability of achieving the market condition in the awards’ fair value. We recognize the expense for such awards ratably over their vesting term.

Expense for stock options without performance or market conditions is determined on the grant date and recognized ratably over their vesting term. We estimate the grant date fair value of stock options using the Black-Scholes model. This model requires us to make various assumptions, with the most significant assumption currently being the volatility of our stock price. A public quotation was first established for our common stock in May 2019, which does not provide adequate historical basis to reasonably estimate the expected volatility of our common stock over their more than six-year expected life. Instead, we estimate volatility based on historical stock price trends of a peer company set. The fair value of our awards would have differed had we selected different peer companies or used a different technique to estimate volatility. Increasing our expected volatility assumption by 5 percentage points for all stock options at the date of grant would have increased our 2022 stock-based compensation expense by $2.1 million.

Estimating the net realizable value of inventories

We value our inventories at the lower of cost or net realizable value. We regularly review quantities of inventories on hand and compare these amounts to the expected use of each product or product line, which can require us to make significant judgments. If our judgments prove to be incorrect, we may be required to record a charge to cost of sales to reduce the carrying amount of inventory on hand to net realizable value. As with any significant estimate, we cannot be certain of future events which may cause us to change our judgments.

Business combinations

We allocate the fair value of purchase consideration to the assets acquired, liabilities assumed, and non-controlling interests in the acquired companies generally based on their fair values at the acquisition date. The excess of the fair value of purchase consideration over the fair value of these assets acquired, liabilities assumed and non-controlling interests in the acquired companies is recorded as goodwill. When determining the fair values of assets acquired, liabilities assumed, and non-controlling interests in the acquired companies, management makes significant estimates related to intangible assets.

Critical estimates in valuing intangible assets include, but are not limited to, expected future cash flows and discount rates. Fair value estimates are based on the assumptions management believes a market participant would use in pricing the asset or liability. Amounts recorded in a business combination may change during the measurement period, which is a period not to exceed one year from the date of acquisitions, as additional information about conditions existing at the acquisition date becomes available.

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