DORMAN PRODUCTS, INC. "Management's Discussion and Analysis of Financial Condition and Results of Operations" should be read in conjunction with the Consolidated Financial Statements and related notes thereto included in Part II, Item 8 of this Annual Report on Form 10-K. The matters discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve significant risks and uncertainties. See the "Statement Regarding Forward Looking Statements" above and Part I, Item 1A, "Risk Factors" in this Annual Report on Form 10-K for additional information regarding forward-looking statements and the factors that could cause actual results to differ materially from those anticipated in the forward-looking statements.
Overview
We are one of the leading suppliers of replacement parts and fasteners for passenger cars, light trucks, and heavy duty trucks in the automotive aftermarket industry. As ofDecember 28, 2019 , we marketed approximately 78,000 unique parts as compared to approximately 77,000 as ofDecember 29, 2018 , many of which we designed and engineered. Unique parts exclude private label stock keeping units ("SKU's") and other variations in how we market, package and distribute our products, but include unique parts of acquired companies. Our products are sold under our various brand names, under our customers' private label brands or in bulk. We are one of the leading aftermarket suppliers of OE "dealer exclusive" parts. OE "dealer exclusive" parts are those parts which were traditionally available to consumers only from original equipment manufacturers or salvage yards. These parts include, among other parts, intake manifolds, exhaust manifolds, window regulators, radiator fan assemblies, tire pressure monitor sensors, complex electronics modules, and exhaust gas recirculation (EGR) coolers. We generate virtually all our net sales from customers in the North American automotive aftermarket industry, primarily inthe United States . Our products are sold primarily through automotive aftermarket retailers, including through their on-line platforms; national, regional and local warehouse distributors and specialty markets, and salvage yards. We also distribute automotive aftermarket parts outsidethe United States , with sales primarily intoCanada andMexico , and to a lesser extent,Europe , theMiddle East andAustralia . We may experience significant fluctuations from quarter to quarter in our results of operations due to the timing of orders placed by our customers. The introduction of new products and product lines to customers, as well as business acquisitions, may also cause significant fluctuations from quarter to quarter. We were engaged in several site consolidation activities during the year endedDecember 28, 2019 . Most significantly, we completed the consolidation of ourMontreal facility (acquired in fiscal 2017 as part of the acquisition ofMAS Automotive Distributors, Inc. ("MAS Industries " or "MAS")) into our new 800,000 square foot distribution center inPortland, Tennessee . Additionally, we transferred our existing distribution operations inPortland, Tennessee to the new facility and also completed the consolidation of an existing production facility inMichigan with our facility inPennsylvania operated by our subsidiary,Flight Systems Automotive Group L.L.C. ("Flight Systems" or "Flight"). During the year endedDecember 28, 2019 , we incurred$3.0 million of costs primarily related to acquisition integration and accelerated depreciation,$2.8 million of which was included in selling, general and administrative expenses and$0.2 million of which was included in gross profit. Additionally, during the year endedDecember 28, 2019 , we incurred$25.9 million of costs related to start up inefficiencies and duplication of facility overhead and operating costs primarily related to ourPortland facility consolidation activities, of which$20.4 million was included in selling, general and administrative expenses and$5.5 million was included in gross profit. As a part of ourPortland consolidation activities, our newPortland distribution center became fully operational inOctober 2019 . We expect our distribution costs to be back to more typical levels as we move through 2020. We operate on a fifty-two, fifty-three week period ended on the last Saturday of the calendar year. The fiscal years endedDecember 28, 2019 ("fiscal 2019"),December 29, 2018 ("fiscal 2018") andDecember 30, 2017 ("fiscal 2017") were fifty-two week periods. 23
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Business Performance Summary
Net sales increased 2% to$991.3 million in fiscal 2019 from$973.7 million in fiscal 2018, while net income decreased 37% to$83.8 million in fiscal 2019 from$133.6 million in fiscal 2018. Additionally, we generated cash flows from operations of$95.3 million in fiscal 2019 and repurchased approximately$143.9 million of our outstanding common stock.
New Product Development
New product development is an important success factor for us and traditionally has been our primary vehicle for growth. We have made incremental investments to increase our new product development efforts each year since 2003 to grow our business and strengthen our relationships with our customers. The investments primarily have been in the form of increased product development resources, increased customer and end-user awareness programs, and customer service improvements. These investments historically have enabled us to provide an expanding array of new product offerings and grow revenues at levels that generally have exceeded market growth rates. As a result of these investments, we introduced 5,239 new products to our customers and end users in fiscal 2019, including 1,625 "New-to-the-Aftermarket" SKU's. One area of focus has been our complex electronics program, which capitalizes on the growing number of electronic components being utilized on today's original equipment platforms. New vehicles contain an average of approximately thirty-five electronic modules, with some high-end luxury vehicles containing over one hundred modules. Our complex electronics products are designed and developed in-house and tested to help ensure consistent performance, and our product portfolio is focused on further developing our leadership position in the category. Another area of focus has been on Dorman HD Solutions™, a line of products we market for the medium and heavy duty truck sector of the automotive aftermarket industry. We believe that this sector provides many of the same opportunities for growth that the passenger car and light truck sector of the automotive aftermarket industry has provided us. Through Dorman HD Solutions™, we specialize in what formerly were "dealer only" parts similar to how we have approached the passenger car and light duty truck sector. During fiscal 2019, we introduced 1,027 SKU's in this product line. We expect to continue to invest aggressively in the medium and heavy duty product category.
Acquisitions
In addition to product development, our growth has been impacted by
acquisitions. In
Economic Factors
The Company's financial results are impacted by various economic and industry
factors, including, but not limited to the number, age and condition of vehicles
in operation ("VIO") at any one time, and miles driven by those VIO.
To begin, the Company's products are primarily purchased and installed on a
subsegment of the VIO, specifically weighted towards vehicles aged eight to
thirteen years old. Each year, the United States seasonally adjusted annual rate
("US SAAR") of new vehicles purchased adds a new year to the US VIO. According
to data from the Auto Care Association ("Auto Care"), the US SAAR experienced a
decline from 2008 to 2011 as consumers purchased fewer new vehicles as a result
of the Great Recession. We believe that the declining US SAAR during that period
resulted in a follow-on decline in our primary US VIO subsegment (eight to
thirteen-year-old vehicles) commencing in 2016. However, following 2011 and the
impact the Great Recession US consumers began to increase their purchases of new
vehicles which over time caused the US SAAR to recover and return to
24
--------------------------------------------------------------------------------more historical levels. Consequently, we expect the US VIO for vehicles aged eight to thirteen years old to recover over the next several years.
In addition, we believe that vehicle owners generally are operating their current vehicles longer than they did several years ago, performing necessary repairs and maintenance in order to keep those vehicles well maintained. According to data published byPolk , a division ofIHS Automotive , the average age of VIO increased to 11.9 years as ofOctober 2019 from 11.8 years as ofOctober 2018 despite increasing new car sales. Additionally, the number of VIO inthe United States continues to increase, growing 2% in 2019 to 290.0 million from 285.7 million in 2018. Approximately 57% of vehicles in operation are 11 years old or older. Vehicle scrappage rates have also decreased over the last several years. Finally, the number of miles driven is another important statistic that impacts our business. According to theUnited States Department of Transportation , the number of miles driven has increased each year since 2011 with miles driven having increased 0.9% as ofNovember 2019 as compared toNovember 2018 . Generally, as vehicles are driven more miles, the more likely it is that parts will fail.
The combination of the factors above has accounted for a portion of our sales growth and is expected to impact our future results.
We operate in a highly competitive market. As a result, we are continuously evaluating our approach to brand, pricing and terms to our different customers and channels. For example, in the third quarter of 2019, we modified our brand protection policy, which is designed to ensure that certain products bearing the Dorman name are not advertised below certain approved pricing levels. Our customers, particularly our larger retail customers, regularly seek more favorable pricing and product return provisions, and extended payment terms when negotiating with us. We attempt to avoid or minimize these concessions as much as possible, but we have granted pricing concessions, indemnification rights, extended customer payment terms and allowed a higher level of product returns in certain cases. These concessions impact net sales as well as our profit levels and may require additional capital to finance the business. We expect our customers to continue to exert pressure on our margins.
Foreign Currency
In fiscal 2019, approximately 79% of our products were purchased from suppliers in a variety of non-U.S. countries. The products generally are purchased through purchase orders with the purchase price specified inU.S. dollars. Accordingly, we generally do not have exposure to fluctuations in the relationship between theU.S. dollar and various foreign currencies between the time of execution of the purchase order and payment for the product. To the extent that theU.S. dollar changes in value relative to foreign currencies in the future, the price of the product for new purchase orders may change in equivalentU.S. dollars. The largest portion of our overseas purchases comes fromChina . The Chinese Yuan toU.S. Dollar exchange rate has fluctuated over the past several years. Any future changes in the value of the Chinese Yuan relative to theU.S. Dollar may result in a change in the cost of products that we purchase fromChina . However, the cost of the products we procure is also affected by other factors including raw material availability, labor cost, and transportation costs. Our acquisition of MAS increased our exposure to foreign currencies. MAS was headquartered inMontreal, Canada , and its financial transactions occur in bothU.S. Dollars and Canadian Dollars. Since our consolidated financial statements are denominated inU.S. Dollars, the assets, liabilities, net sales, and expenses of MAS which are denominated in currencies other than theU.S. Dollar must be converted intoU.S. Dollars using exchange rates for the current period. As a result, fluctuations in foreign currency exchange rates may impact our financial results. In early 2019, we completed the consolidation of ourMontreal facility into our newPortland, Tennessee facility, which reduced our Canadian Dollar exposure. Impact of Inflation
The overall impact of inflation has not resulted in a significant change in labor costs or the cost of general services utilized.
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The cost of many commodities that are used in our products has fluctuated over
time resulting in increases and decreases in the cost of our products. In
addition, we have periodically experienced increased transportation costs as a
result of higher fuel prices, capacity constraints and other factors. We will
attempt to offset cost increases by passing along selling price increases to
customers, using alternative suppliers and sourcing purchases from other
suppliers. However, there can be no assurance that we will be successful in
these efforts.
Impact of Tariffs
EffectiveSeptember 24, 2018 , theOffice of the United States Trade Representative (USTR) imposed an additional tariff on approximately$200 billion worth of Chinese imports. The tariff was approximately 10% as ofDecember 29, 2018 . Effective for shipments departingChina on or afterMay 10, 2019 , the USTR increased this tariff to 25%. In addition, effectiveSeptember 1, 2019 , the USTR imposed a fourth tranche of tariffs on approximately$300 billion worth of Chinese imports with a tariff rate of 15%. The tariffs enacted to date will increase the cost of many products that are manufactured for us inChina . We are taking several actions to mitigate the impact of the tariffs including, but not limited to, price increases to our customers and cost concessions from our suppliers. We expect to continue mitigating the impact of tariffs in fiscal 2020 primarily through selling price increases to offset the higher tariffs incurred. Tariffs are not expected to have a material impact on our net income but are expected to increase net sales and lower our gross and operating profit margins to the extent that these additional costs are passed through to customers. InJanuary 2020 , theU.S. and Chinese governments signed a trade deal that reduced someU.S. tariffs on Chinese goods in exchange for Chinese pledges to, among other things, purchase more of American farm, energy and manufactured goods. In addition, the USTR has granted tariff relief for certain categories of products being imported fromChina . We expect that we will reverse tariff-related price increases previously passed along to our customers and cost concessions previously received from our suppliers as such tariffs are reduced or such other relief is granted.
Results of Operations
The following table sets forth, for the periods indicated, the dollar value and percentage of net sales represented by certain items in our Consolidated Statements of Operations:
For the Fiscal Year Ended
(in millions, except percentage
data) December 28, 2019 December 29, 2018 December 30, 2017
Net sales $ 991.3 100.0 % $ 973.7 100.0 % $ 903.2 100.0 %
Cost of goods sold $ 651.5 65.7 % $ 600.4 61.7 % $ 544.6 60.3 %
Gross profit $ 339.8 34.3 % $ 373.3 38.3 % $ 358.6 39.7 %
Selling, general and
administrative expenses $ 234.0 23.6 % $ 202.1 20.8 % $ 182.4 20.2 %
Income from operations $ 105.8 10.7 % $ 171.1 17.6 % $ 176.2 19.5 %
Other (expense) income, net $ - 0.0 % $ - 0.0 % $ 0.3 0.0 %
Income before income taxes $ 105.8 10.7 % $ 171.1 17.6 % $ 176.6 19.6 %
Provision for income taxes $ 22.0 2.2 % $ 37.5 3.9 % $ 70.0 7.7 %
Net income $ 83.8 8.4 % $ 133.6 13.7 % $ 106.6 11.8 %
* Percentage of sales information does not add due to rounding
Fiscal Year Ended
Net sales increased 2% to$991.3 million in fiscal 2019 from$973.7 in fiscal 2018. Acquisitions contributed to 1% of the sales growth. The remaining growth experienced by our base business was attributable to approximately a 3.5% increase as a result of tariff-related pricing increases, partially offset by a shift in customer mix from warehouse distributor customers to retail customers. Gross profit margin was 34.3% of net sales in fiscal 2019 compared to 38.3% of net sales in fiscal 2018. The gross profit margin declined primarily as a result of a change in customer mix from warehouse distributor to retail customers, the pass-through of tariff costs to our customers, acquisitions completed in the last 12 months which carry lower gross margins compared to our historical levels, and redundant overhead costs as a result the duplication of facility and operating costs related to our distribution center consolidation inPortland, Tennessee . 26
-------------------------------------------------------------------------------- Selling, general and administrative expenses were$234.0 million , or 23.6% of net sales, in fiscal 2019 compared to$202.1 million , or 20.8% of net sales, in fiscal 2018. The increase in selling, general and administrative expense during the year was primarily due to$20.4 million of expenses associated with start-up inefficiencies and the duplication of facility and operating costs related to our distribution center consolidation inPortland, Tennessee and higher factoring costs due to increased sales of accounts receivable. Our effective tax rate decreased to 20.8% in fiscal 2019 from 21.9% in fiscal 2018. The effective tax rate decreased primarily due to lower income of foreign entities included within the consolidatedU.S. tax group.
Fiscal Year Ended
Net sales increased 8% to$973.7 million in fiscal 2018 from$903.2 in fiscal 2017. Our revenue growth was driven by overall strong demand for our products and the inclusion of revenue from acquired businesses. In fiscal 2018, approximately$48.3 million of net sales were attributed to acquisitions. Our growth was partially offset by negative effects of a brand protection policy implemented in the fourth quarter of 2017. Gross profit margin was 38.3% in fiscal 2018 compared to 39.7% in fiscal 2017. The decreased gross profit margin was primarily the result of the impact of acquisitions which carry lower gross margins compared to our historical levels. Additionally, the 2018 gross profit margin was negatively impacted by a$2.0 million inventory fair value adjustment resulting from business acquisitions, lower overall selling prices and an unfavorable shift in mix towards lower margin products. Selling, general and administrative expenses were$202.1 million , or 20.8% of net sales, in fiscal 2018 compared to$182.4 million , or 20.2% of net sales, in fiscal 2017. The increase in expense was primarily due to the inclusion of the expenses of acquired operations, amortization expense of acquired intangible assets, reinvestment of tax savings in product development and sales organizations, an increase in wage and benefit costs and increased costs associated with our accounts receivable sales program. Our effective tax rate decreased to 21.9% in fiscal 2018 from 39.6% in fiscal 2017. The decrease was attributable to the Tax Cuts and Jobs Act enacted inthe United States inDecember 2017 , which lowered theU.S. Corporate federal income tax rate to 21% beginning in 2018.
Liquidity and Capital Resources
Historically, our primary sources of liquidity have been our invested cash and the cash flow we generate from our operations, including accounts receivable sales programs provided by certain customers. Cash and cash equivalents atDecember 28, 2019 increased to$68.4 million from$43.5 million atDecember 29, 2018 . Working capital was$534.1 million atDecember 28, 2019 compared to$488.1 million atDecember 29, 2018 . Shareholders' equity was$773.6 million atDecember 28, 2019 and$727.6 million atDecember 29, 2018 . Based on our current operating plan, we believe that our sources of available capital are adequate to meet our ongoing cash needs for at least the next twelve months. However, our liquidity could be negatively affected by extending payment terms to customers, a decrease in demand for our products, the outcome of contingencies or other factors. See Note 11, "Commitments and Contingencies", in the accompanying consolidated financial statements for additional information regarding commitments and contingencies that may affect our liquidity. Over the past several years we have continued to extend payment terms to certain customers as a result of customer requests and market demands. These extended terms have resulted in increased accounts receivable levels and significant uses of cash flows. Tariffs also increase our uses of cash since we pay for the tariffs upon the arrival of our goods inthe United States but collect the cash on any passthrough price increases from our customers on a delayed basis according to the payment terms negotiated with our customers. We participate in accounts receivable sales programs with several customers which allow us to sell our accounts receivable to financial institutions to offset the negative cash flow impact of these payment terms extensions. However, any sales of accounts receivable through these programs ultimately result in us receiving a lesser amount of cash upfront than if we collected those accounts receivable ourselves in due course. Moreover, prior to LIBOR being phased out in 2021, to the extent that any of these accounts receivable sales programs bear interest rates tied to LIBOR, as LIBOR rates increase our cost to sell our receivables also increase. See Item 7A. Quantitative and Qualitative Disclosures about Market Risk for more information. During fiscal 2019 and fiscal 2018, we sold approximately$676.4 million and$604.7 million , respectively, under these programs. We had the ability to sell significantly more accounts receivable under these 27 -------------------------------------------------------------------------------- programs if the needs of the business warranted. Further extensions of customer payment terms will result in additional uses of cash flow or increased costs associated with the sales of accounts receivable. InDecember 2017 , we entered into a credit agreement that will expire inDecember 2022 . The credit agreement provides for an initial revolving credit facility of$100.0 million and, subject to certain requirements, gives us the ability to request increases of up to an incremental$100.0 million . The credit agreement replaced our previous$30.0 million facility. Borrowings under the credit agreement are on an unsecured basis. At the Company's election, the interest rate applicable to revolving credit loans under the credit agreement will be either (1) the Prime Rate as announced by Wells Fargo from time to time, (2) an Adjusted LIBOR Market Index Rate as measured by the LIBOR Market Index Rate plus the Applicable Margin which fluctuates between 65 basis points and 125 basis points based on the ratio of the Company's Consolidated Funded Debt to Consolidated EBITDA, or (3) an Adjusted LIBOR Rate as measured by the LIBOR Rate plus the Applicable Margin which fluctuates between 65 basis points and 125 basis points based on the ratio of the Company's Consolidated Funded Debt to Consolidated EBITDA. The interest rate atDecember 28, 2019 was LIBOR plus 65 basis points (2.45%). During the occurrence and continuance of an event of default, all outstanding revolving credit loans will bear interest at a rate per annum equal to 2.00% in excess of the greater of (1) the Prime Rate or (2) the Adjusted LIBOR Market Index Rate then applicable. As ofDecember 28, 2019 , we were not in default in respect to the credit agreement. The credit agreement also contains covenants, including those related to the ratio of certain consolidated fixed charges to consolidated EBITDA, capital expenditures, and share repurchases, each as defined by the credit agreement. The credit agreement also requires us to pay an unused fee of 0.10% on the average daily unused portion of the facility, provided the unused fee will not be charged on the first$30 million of the revolving credit facility. As ofDecember 28, 2019 , there were no borrowings under the credit agreement and we had two outstanding letters of credit for approximately$0.8 million in the aggregate which were issued to secure ordinary course of business transactions. Net of these letters of credit, we had approximately$99.2 million available under the credit agreement atDecember 28, 2019 .
Cash Flows
Below is a table setting forth the key lines of our Consolidated Statements of
Cash Flows:
December 28, December 29, December 30,
(in thousands) 2019 2018 2017
Cash provided by operating activities $ 95,306 $ 78,112 $ 94,241
Cash used in investing activities (29,560 ) (59,146 ) (94,437 )
Cash used in financing activities (40,851 ) (46,938 ) (77,271 )
Effect of exchange rate changes on cash and
cash equivalents - (261 ) 37
Net increase (decrease) in cash and cash
equivalents $ 24,895 $ (28,233 ) $ (77,430 )
During fiscal 2019, cash provided by operating activities was $95.3 million ,
primarily as a result of $83.8 million in net income, non-cash adjustments to
net income of $30.1 million and a net increase in operating assets and
liabilities of $18.5 million . Accounts receivable decreased $8.8 million due to
the timing and factoring of receivables during the year. Inventory increased
$11.0 million due to higher inventory purchases to support new product launches
and maintain customer fill rates as we consolidated facilities. Accounts payable
decreased by $19.1 million due to the timing of payments to our vendors. Other
assets and liabilities, net, increased $6.3 million .
During fiscal 2018, cash provided by operating activities was $78.1 million ,
primarily as a result of $133.6 million in net income, non-cash adjustments to
net income of $31.2 million and a net increase in operating assets and
liabilities of $86.7 million . Accounts receivable increased $61.4 million due to
increased net sales, which were partially offset by increased accounts
receivable sales. Inventory increased $46.8 million due to higher inventory
purchases to avoid potentially higher tariffs, to support new product launches
and maintain customer fill rates as we consolidated facilities. Accounts payable
increased by $27.0 million due to increased inventory and the timing of payments
to our vendors. Other assets and liabilities, net, increased $0.2 million .
During fiscal 2017, cash provided by operating activities was $94.2 million ,
primarily as a result of $106.6 million in net income, non-cash adjustments to
net income of $30.4 million and a net increase in operating assets
28
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and liabilities of $42.7 million . Accounts receivable increased $5.7 million due
to increased net sales and the timing of cash receipts at year end. Inventory
increased $25.1 million due to higher inventory purchases to support new product
launches and to improve customer fill rates. Accounts payable increased by $3.7
million due to increased inventory and the timing of payments to our vendors.
Other assets and liabilities, net, increased $15.6 million primarily due to an
increase in long-term core inventory and a decrease in customer rebates that we
expected to settle in cash.
Investing activities used
• Capital spending in fiscal 2019 was primarily related to
in tooling associated with new products, $6.3 million inenhancements
and upgrades to our information systems and infrastructure, scheduled
equipment replacements, certain facility improvements and other
capital projects.
• Capital spending in fiscal 2018 was primarily related to $8.5 million
in tooling associated with new products, $6.8 million inenhancements
and upgrades to our information systems and infrastructure, scheduled
equipment replacements, certain facility improvements and other
capital projects.
• Capital spending in fiscal 2017 was primarily related to
in tooling associated with new products, $7.7 million inenhancements
and upgrades to our information systems, scheduled equipment
replacements, certain facility improvements and other capital
projects.
• During fiscal 2018, we used $27.5 million to acquire all of the
outstanding equity of Flight Systems and $5.0 million toacquire a
minority interest in a vehicle diagnostic tool developer.During
fiscal 2017, we used $56.9 million to acquire the outstanding shares
of MAS, $10.0 million to acquire a minority equity interest in a
supplier, and $3.1 million to acquire certain assets of achassis and
suspension business.
Cash used in financing activities was
• On
authorized a share repurchase program. In fiscal 2019, we paid $39.4
million to repurchase 499,564 common shares. In fiscal 2018, we paid
$43.4 million to repurchase 622,223 common shares. In fiscal 2017, we
paid $74.7 million to repurchase 1,006,365 common shares.
• The remaining uses of cash from financing activities in each period
result from stock compensation plan activity and the repurchase of
shares of our common stock held in a fund in our 401(k) Plan. 401(k)
Plan participants can no longer purchase shares of Dormancommon stock
as an investment option under the 401(k) Plan. Shares are generally
purchased from the 401(k) Plan when participants sell units as
permitted by the 401(k) Plan or elect to leave the 401(k) Plan upon
retirement, termination or other reasons.
Contractual Obligations and Commercial Commitments
We have obligations for future minimum rental payments and similar commitments under non-cancellable operating leases as well as contingent obligations related to outstanding letters of credit. These obligations as ofDecember 28, 2019 are summarized in the tables below (in thousands): Payments Due by Period Less than Contractual Obligations Total 1 year 1-3
years 3-5 years Thereafter Operating leases$ 45,170 $ 6,935 $ 9,881 $ 6,840 $ 21,514 $ 45,170 $ 6,935 $ 9,881 $ 6,840 $ 21,514 29
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Amount of Commitment Expiration Per Period
Total Amount Less than
Other Commercial Commitments Committed 1 year 1-3 years 3-5 years Thereafter
Letters of Credit $ 825 $ 825 $ - $ - $ -
$ 825 $ 825 $ - $ - $ -
We have excluded from the table above contingent consideration related to the
acquisition of MAS due to the uncertainty of the amount of payment. As of
December 28, 2019 , the Company has accrued approximately $5.6 million which
represents the fair value of the estimated payments which will become due if
certain sales thresholds are achieved through December 2020 and will be paid out
in 2021.
We have excluded the $2.8 million estimated accrual related to the underpayment
of duties to the United States Customs & Border Protection since the ultimate
resolution of this matter is uncertain and is not expected to be resolved within
the next twelve months (see Note 11, Commitments and Contingencies included in
this annual report Form 10-K).
Additionally, we have excluded from the table above unrecognized tax benefits
due to the uncertainty of the amount and period of payment. As of December 28,
2019 , the Company has gross unrecognized tax benefits of $2.3 million (see Note
10, Income Taxes, to the Consolidated Financial Statements included in this
Annual Report on Form 10-K).
Off-Balance Sheet Arrangements
Off-balance sheet arrangements are transactions, agreements, or other contractual arrangements with an unconsolidated entity for which we have an obligation to the entity that is not recorded in our consolidated financial statements. We historically have not utilized off-balance sheet financial instruments, and do not plan to utilize off-balance sheet arrangements in the future to fund our working capital requirements, operations or growth plans.
We may issue stand-by letters of credit under our credit agreement. Letters of credit totaling$0.8 million were outstanding at each ofDecember 28, 2019 andDecember 29, 2018 . Those letters of credit are issued primarily to satisfy the requirements of workers compensation, general liability and other insurance policies. Each of the outstanding letters of credit has a one-year term from the date of issuance.
We do not have any off-balance sheet financing that has, or is reasonably likely to have, a material, current or future effect on our financial condition, revenues, expenses, cash flows, results of operations, liquidity, capital expenditures or capital resources.
Related-Party Transactions
We have a non-cancelable operating lease for our primary operating facility from a partnership in whichSteven L. Berman , our Executive Chairman, and his family members are partners. Total annual rental payments each year to the partnership under the lease arrangement were$1.6 million in each of fiscal 2019, fiscal 2018, and fiscal 2017. In the opinion of our Audit Committee, the terms and rates of this lease are no less favorable than those which could have been obtained from an unaffiliated party when the lease was renewed inNovember 2016 . We are a partner in a joint venture with one of our suppliers and we own a minority interest in two other suppliers. Purchases from these companies, since we acquired our investment interests were$23.2 million in fiscal 2019 and$20.3 million in fiscal 2018 and$16.5 million in fiscal 2017.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon the Consolidated Financial Statements, which have been prepared in accordance withU.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities and the reported 30 -------------------------------------------------------------------------------- amounts of revenues and expenses. We regularly evaluate our estimates and judgments, including those related to revenue recognition, customer rebates and returns, inventories, long-lived assets and purchase accounting. Estimates and judgments are based upon historical experience and on various other assumptions believed to be accurate and reasonable under the circumstances. Actual results may differ materially from these estimates due to different assumptions or conditions. We believe the following critical accounting policies affect our more significant estimates and judgments used in the preparation of our Consolidated Financial Statements. Revenue Recognition and Accrued Customer Rebates and Returns. Revenue is recognized from product sales when goods are shipped, title and risk of loss and control have been transferred to the customer and collection is reasonably assured. We record estimates for cash discounts, product returns, promotional rebates, core return deposits and other discounts in the period of the sale ("Customer Credits"). The provision for Customer Credits is recorded as a reduction from gross sales and reserves for Customer Credits are shown as an increase in accrued customer rebates and returns, which is included in current liabilities. Actual Customer Credits have not differed materially from estimated amounts for each period presented. Amounts billed to customers for shipping and handling are included in net sales. Costs associated with shipping and handling are included in cost of goods sold. Excess and Obsolete Inventory Reserves. We must make estimates of potential future excess and obsolete inventory costs. We provide reserves for discontinued and excess inventory based upon historical demand, forecasted usage, estimated customer requirements and product line updates. We maintain contact with our customer base in order to understand buying patterns, customer preferences and the life cycle of our products. Changes in customer requirements are factored into the reserves, as needed. Long-Lived Assets Including Goodwill and Other Acquired Intangible Assets. Long-lived assets, including property, plant, and equipment and amortizable identifiable intangibles, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. The impairment review is a two-step process. First, recoverability is measured by comparing the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount exceeds the estimated undiscounted future cash flows, the second step of the impairment test is performed and an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds its fair value. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposal group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.Goodwill is reviewed for impairment on an annual basis or whenever events or changes in circumstances indicate the carrying value of the goodwill may be impaired. In regards to the annual test, we have the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we determine it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. During fiscal 2019 and fiscal 2018, we assessed the qualitative factors which could affect the fair values of our reporting units and determined that it was not more likely than not that the fair values of each reporting unit was less than its carrying amount. Purchase Accounting. The purchase price of an acquired business is allocated to the underlying tangible and intangible assets acquired and liabilities assumed based upon their respective fair market values, with any excess recorded as goodwill. Such fair market value assessments require judgements and estimates which may change over time and may cause the final amounts to differ materially from their original estimates. Any adjustments to fair value assessments are recorded to goodwill over the purchase price allocation period which cannot exceed twelve months from the date of acquisition.
New and Recently Adopted Accounting Pronouncements
Refer to Note 2, New and Recently Adopted Accounting Pronouncements, to the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K, which is incorporated herein.
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