JOHNSON OUTDOORS INC 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Unless otherwise stated, all monetary amounts in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, other than per share amounts, are stated in thousands. Executive Overview The Company designs, manufactures and markets high quality recreational products for the outdoor enthusiast. Through a combination of innovative products, strong marketing, a talented and passionate workforce and efficient distribution, the Company seeks to set itself apart from the competition in its markets. Its subsidiaries operate as a network that promotes innovation and leverages best practices and synergies, following the strategic vision set by executive management and approved by the Company’s Board of Directors. Coronavirus (COVID-19) Due to the timing of the COVID-19 outbreak, the Company's primary-selling season during fiscal 2020 was interrupted resulting in a significant shift in sales volumes during the 2020 fiscal year toward the latter half of that fiscal year versus the 17 Table of Contents prior year period where our heaviest sales volumes occurred during our second and third fiscal quarters. As stay at home restrictions were lifted, the Company saw an increase in demand for many of its warm weather outdoor recreational products later during fiscal 2020 as consumers took advantage of being outdoors. As a result, each of our Fishing, Camping and Watercraft Recreation segments experienced strong demand in the latter half of the current fiscal year. Due to the unique aspects of this pandemic and the various government prescriptions for the general public to maintain social distancing and avoid activities involving large crowds or being in confined spaces with others to mitigate the spread of the virus, the warm weather outdoor recreation industry benefited from increased participation in outdoor recreation activities. While it is difficult to know the longer-term impacts from the COVID-19 pandemic on demand for the Company's products, as a Company with product offerings in several segments that allow consumers to engage in socially distant and relatively pandemic-safe activities outdoors, the Company intends to leverage the current situation with disciplined investments for future, long-term growth in spite of the ongoing COVID-19 pandemic. Highlights The Company's fiscal year ended October 2, 2020 comprised 53 weeks, whereas fiscal 2019 and 2018 each comprised 52 weeks. The additional week in fiscal 2020 increased net sales by less than 2% over the prior year. The Company’s fiscal 2020 revenues increased by 6% over the prior year, driven primarily by strong performance in the Fishing, Camping and Watercraft Recreation segments where the Company saw strong demand for its outdoor recreation products as a result of consumers recreating outdoors in light of COVID-19. Operating profit in 2020 increased $7,296, or 11%, over 2019. Results of Operations Summary consolidated financial results from continuing operations for the fiscal years presented were as follows: (thousands, except per share data) 2020 2019 2018 Net sales $ 594,209 $ 562,419 $ 544,268 Gross profit 264,993 249,756 241,860 Operating expenses 193,923 185,982 178,839 Operating profit 71,070 63,774 63,021 Interest expense 143 172 203 Other income, net (2,775) (796) (4,122) Income tax expense 18,469 15,094 27,437 Net income 55,233 51,413 40,669 The Company’s internal and external sales and operating profit (loss) by business segment for each of the three most recent completed fiscal years were as follows: 2020 2019 2018 Net sales: Fishing $ 449,878 $ 412,121 $ 391,110 Camping 41,592 40,379 37,770 Watercraft Recreation 41,857 33,498 36,280 Diving 60,873 76,306 78,932 Other / Eliminations 9 115 176 $ 594,209 $ 562,419 $ 544,268 18 Table of Contents 2020 2019 2018 Operating profit (loss): Fishing $ 95,884 $ 84,092 $ 83,696 Camping 4,406 2,896 1,867 Watercraft Recreation (329) (2,822) (1,555) Diving (2,576) 3,043 2,766 Other / Eliminations (26,315) (23,435) (23,753) $ 71,070 $ 63,774 $ 63,021 See Note 13 to the Consolidated Financial Statements included elsewhere in this report for the definition of segment net sales and operating profit. Fiscal 2020 vs. Fiscal 2019 Net Sales Net sales in 2020 increased by 6% to $594,209 compared to $562,419 in 2019. The additional week in the fiscal year drove an increase in net sales of approximately 1.5% over the prior year. Foreign currency exchange had a $651 unfavorable impact, less than 1%, on the current year’s sales versus the prior year. Net sales for the Fishing business increased by $37,757, or 9% during 2020 from 2019. Increased demand late in the fiscal year was more than enough to overcome the impact of COVID-19 related restrictions and shutdowns earlier in the fiscal year, resulting in the increase in the current year over the prior year. Camping net sales increased $1,213, or 3%, in 2020 from 2019. Increased sales of consumer tents and Jetboil products as a result of increased participation in outdoor recreation activities were more than enough to overcome declines in military tent sales year over year. Net sales in the Watercraft Recreation business increased $8,359, or 25%. Despite COVID-19 related shutdowns earlier in the year, increased demand later in the year drove the overall increase over the prior year. See "Coronavirus (COVID-19)" above for more information regarding the impact the COVID-19 pandemic had on our fiscal 2020 sales. Diving net sales decreased $15,433, or 20%, year over year. The decrease is largely due to the effects of COVID-19 on demand globally due to restrictions in destination travel and tourism. In addition, foreign currency translation negatively impacted sales by approximately 1% in 2020 versus the prior year period. Cost of Sales Cost of sales was $329,216, or 55.4% of net sales, on a consolidated basis for fiscal 2020 compared to $312,663, or 55.6% of net sales, in the prior year. Higher sales volumes between years were the primary driver of the increase in the cost of sales between periods. Additionally, the impact of approximately $2,000 of additional tariffs during fiscal 2020, which have increased our cost of sales, on Chinese goods and components over the prior year was offset by favorable product mix and pricing between fiscal years. Gross Profit Gross profit of $264,993 was 44.6% of net sales on a consolidated basis for the year ended October 2, 2020 compared to $249,756, or 44.4% of net sales in the prior year. Gross profit in the Fishing business increased by $18,625 from the prior year due primarily to the 9% increase in net sales year over year. The recovery of overpayments of excise taxes during fiscal 2020 more than offset approximately $1,000 of new tariff costs on Chinese sourced goods and components incurred during fiscal 2020. Camping gross profit increased by $1,321 from 2019 due primarily to increased sales volumes and a favorable mix of products sold in the current year as compared to the prior year. Gross profit in the Watercraft Recreation segment increased by $3,840 from 2019 due primarily to increased sales volumes in 2020 versus the prior year and the resulting improvement in absorption of overhead costs. 19 Table of Contents The $8,467 decrease in gross profit in the Diving segment was due primarily to decreased sales volumes during fiscal 2020 as compared to the prior year. Operating Expenses Operating expenses increased from the prior year by $7,941. The increase was driven primarily by higher sales volume related costs incurred in fiscal 2020 as compared to the prior fiscal year. Additionally, increased headcount and people costs further increased expenses year over year. Operating expenses for the Fishing segment increased by $6,832 from fiscal 2019 levels. The increase was due primarily to higher sales volume related expenses between years and increased headcount related expenses incurred in fiscal 2020. Camping operating expenses decreased by $189 from the prior year due primarily to efforts to reduce spending in light of COVID-19 uncertainties during the current year, primarily as it related to travel, entertainment and advertising expenses. In the Watercraft Recreation segment, operating expenses increased $1,347 from their levels in fiscal 2019 due primarily to increased sales volume related expenses in 2020. Operating expenses for the Diving business decreased by $2,848 year over year due primarily to lower sales volume related expenses, as well as lower headcount related expenses between periods. The Company's 2020 general corporate expenses of $26,490 increased $2,799 from $23,961 in 2019. The year over year increase primarily reflects $1,800 of higher deferred compensation expenses, as well as higher health insurance costs offset in part by decreased investment in marketing support over the prior year. Operating Results The Company’s operating profit was $71,070 in fiscal 2020 compared to an operating profit of $63,774 in fiscal 2019. Fishing operating profit increased by $11,792 to $95,884 from $84,092 in the prior year due primarily to higher sales volumes between years. The operating profit for Camping was $4,406 compared to $2,896 in 2019 which increase was also primarily a result of higher sales volumes between periods. The operating loss for the Watercraft Recreation business was $329 in fiscal 2020 compared to a loss of $2,822 in fiscal 2019 due to the factors noted above on changes in sales volumes and operating expenses. Operating profit for the Diving business decreased by $5,619 in fiscal 2020 from fiscal 2019, due to the impact of COVID-19 and demand for our Diving products and the other factors discussed above. Other Income and Expenses Interest expense of $143 declined slightly from the prior year expense of $172. Interest income of $1,413 decreased from prior year interest income of $2,109 due to declining interest rates in 2020. Net other income of $1,362 in fiscal 2020 increased from net other income of $796 in fiscal 2019. The current year net other income included currency losses of $269 and market gains and dividends of $2,454 on deferred compensation plan assets. In the prior year, net other income included $645 of currency gains and $610 of market gains and dividends on the deferred compensation plan assets. The dividends and market gains and losses on deferred compensation plan assets recognized in the Consolidated Statement of Operations in “Other income, net” are offset as compensation expense in “Operating expenses.” Pretax Income and Income Taxes The Company realized pretax income of $73,702 in fiscal 2020 compared to $66,507 in fiscal 2019. The Company recorded income tax expense of $18,469 in 2020, which equated to an effective tax rate of 25.1%, compared to $15,094 in 2019, which equated to an effective tax rate of 22.7%. Net Income The Company recognized net income of $55,233, or $5.47 per diluted common share, in fiscal 2020 compared to $51,413, or $5.11 per diluted common share, in fiscal 2019 based on the factors discussed above. Fiscal 2019 vs. Fiscal 2018 Net Sales 20 Table of Contents Net sales in 2019 increased by 3% to $562,419 compared to $544,268 in 2018. Foreign currency exchange had a $3,170 unfavorable impact, less than 1%, on the 2019 fiscal year’s sales versus the prior year. Net sales for the Fishing business increased by $21,011, or 5% during 2019 from 2018. Strong performance of new products, particularly from the Humminbird brand, drove the growth over the prior year. Camping net sales increased $2,609, or 7%, in 2019 from 2018. Increased military tent sales, as well as increased sales of Jetboil products over the prior year were the primary drivers for growth year over year. Net sales in the Watercraft Recreation business decreased $2,782, or 8%, between years due to a weakened paddling market and lost distribution related to retail consolidations. Diving net sales decreased $2,626, or 3%, year over year. Growth in the US market was more than offset by declines in the Asia market and foreign currency translation, which negatively impacted sales by 3% in 2019 versus the prior year period. Cost of Sales Cost of sales was $312,663, or 55.6% of net sales, on a consolidated basis for fiscal 2019 compared to $302,408, or 55.6% of net sales, in the prior year. Higher sales volumes between years were the primary driver of the increase in the cost of sales. Additionally, the impact of approximately $2,900 of additional tariffs during 2019, which increased our cost of sales, on Chinese goods and components over the prior year was offset by favorable product mix and pricing between fiscal years. Gross Profit Gross profit of $249,756 was 44.4% of net sales on a consolidated basis for the year ended September 27, 2019 compared to $241,860, or 44.4% of net sales in the prior year. Gross profit in the Fishing business increased by $7,896 in 2019 from the prior year due primarily to the 5% increase in net sales year over year. A sales mix shift to higher value new products during fiscal 2019 more than offset the effect of approximately $2,600 of new tariffs on Chinese sourced goods and components. Camping gross profit increased in 2019 by $1,390 from 2018 due primarily to increased sales volume between years, a favorable mix of products sold and fewer closeouts in the current year as compared to the prior year. Gross profit in the Watercraft Recreation segment decreased in 2019 by $928 from 2018 levels due primarily to lower sales volumes occurring during 2019. The $465 decrease in gross profit in the Diving segment was due primarily to the unfavorable impact of foreign currency translation in that segment during fiscal 2019. Operating Expenses Operating expenses increased in 2019 from the prior year by $7,143. The increase was driven primarily by higher sales volume related costs and bad debt expenses incurred in fiscal 2019. Additionally, investment in marketing support further increased expenses year over year. Operating expenses for the Fishing segment increased in 2019 by $7,501 from fiscal 2018 levels. The increase was due primarily to higher sales volume related expenses and bad debt expenses incurred in fiscal 2019. In addition, higher research and development expenses further contributed to the increase between years. Camping operating expenses increased in 2019 by $361 from the prior year due primarily to increased sales volume related expenses in 2019. In the Watercraft Recreation segment, operating expenses increased $339 from their levels in fiscal 2018 due primarily to increased advertising and freight expenses in 2019. Operating expenses for the Diving business decreased by $740 year over year due primarily to lower headcount related expenses between periods. 21 Table of Contents The Company's 2019 general corporate expenses of $23,691 decreased $317 from $24,008 in 2018. The year over year decrease primarily reflects lower deferred compensation and health insurance costs offset in part by investment in marketing support. Operating Results The Company’s operating profit was $63,774 in fiscal 2019 compared to an operating profit of $63,021 in fiscal 2018. Fishing operating profit increased in 2019 by $396 to $84,092 from $83,696 in 2018 due primarily to higher sales volumes between years. The operating profit for Camping was $2,896 in 2019 compared to $1,867 in 2018 which increase was due primarily as a result of higher sales volumes between periods. The operating loss for the Watercraft Recreation business was $2,822 in fiscal 2019 compared to a loss of $1,555 in fiscal 2018 due to the factors noted above. Operating profit for the Diving business increased by $277 in fiscal 2019 from fiscal 2018. Other Income and Expenses Interest expense of $172 in 2019 declined slightly from the prior year expense of $203. Interest income of $2,109 in 2019 increased from 2018 interest income of $1,166 due to the increase in cash and cash equivalents and rising interest rates in 2019. Net other income of $796 in fiscal 2019 decreased from net other income of $4,122 in fiscal 2018. The current year other income during 2019 included currency gains of $645 and market gains and dividends of $610 on deferred compensation plan assets. In 2018, other income included $1,985 of currency gains and $1,734 of market gains and dividends on the deferred compensation plan assets. The dividends and market gains and losses on deferred compensation plan assets recognized in the Consolidated Statement of Operations in “Other income, net” are offset as compensation expense in “Operating expenses.” Pretax Income and Income Taxes The Company realized pretax income of $66,507 in fiscal 2019 compared to $68,106 in fiscal 2018. The Company recorded income tax expense of $15,094 in 2019, which equated to an effective tax rate of 22.7%, compared to $27,437 in 2018, which equated to an effective tax rate of 40.3%. The fiscal 2018 expense reflects the impact of provisional tax expense of $8,456 from the enactment of U.S. Tax Cuts & Jobs Act during the prior year. Net Income The Company recognized net income of $51,413, or $5.11 per diluted common share, in fiscal 2019 compared to $40,669, or $4.05 per diluted common share, in fiscal 2018 based on the factors discussed above. Financial Condition, Liquidity and Capital Resources The Company believes its existing balances of cash, cash equivalents and short-term investments will be sufficient to satisfy its working capital needs, capital asset purchase requirements, outstanding commitments and other liquidity requirements associated with its existing operations over the next twelve months. The Company currently anticipates the cash used for future dividends will come from its current cash and cash generated from ongoing operating activities. The Company considers all short-term investments in interest-bearing bank accounts, and all securities and other instruments with an original maturity of three months or less, to be equivalent to cash. Short-term investments in prior years consisted of certificates of deposit, with original maturities greater than three months but less than one year, with the primary objective of minimizing the potential risk of principal loss. The Company’s investment policy generally requires securities to be investment grade. The Company’s cash flows from operating, investing and financing activities, as reflected in the accompanying Consolidated Statements of Cash Flows, are summarized in the following table: 22 Table of Contents Year Ended (thousands) October 2 2020 September 27 2019 September 28 2018 Cash provided by (used for): Operating activities $ 61,493 $ 45,844 $ 63,358 Investing activities (15,587) 11,989 48 Financing activities (7,107) (6,186) (4,935) Effect of foreign currency rate changes on cash 1,256 (1,142) (404) Increase (decrease) in cash and cash equivalents $ 40,055 $ 50,505 $ 58,067 Operating Activities The following table sets forth the Company’s working capital position at the end of each of the years shown: (thousands, except share data) October 2 2020 September 27 2019 Current assets $ 388,538 $ 322,528 Current liabilities 105,607 87,866 Working capital $ 282,931 $ 234,662 Current ratio 3.7:1 3.7:1 Cash flows provided by operations totaled $61,493, $45,844 and $63,358 in fiscal 2020, 2019 and 2018, respectively. Cash flows provided by operations increased from the prior year due primarily to an increase in net income in fiscal 2020, as well as working capital changes. Depreciation and amortization charges were $14,926, $13,964 and $13,105 in fiscal 2020, 2019 and 2018, respectively. Investing Activities Cash flows used for investing activities were $15,587 in fiscal 2020, and cash flows provided by investing activities were $11,989, and $48 in fiscal 2019, and 2018, respectively. There were no sales or purchases of short-term investments in fiscal 2020, while proceeds from the sale of short-term investments in 2019 provided cash of $35,838, offset by purchases of $7,124. In fiscal 2018, the sale of short-term investments provided cash of $52,682, offset by purchases of $34,789. Expenditures for property, plant and equipment were $15,600, $16,786 and $19,152 in fiscal 2020, 2019 and 2018, respectively. In general, the Company’s ongoing capital expenditures are primarily related to tooling for new products and facilities and information systems improvements. Financing Activities Cash flows used for financing activities totaled $7,107 in fiscal 2020 compared to $6,186 and $4,935 in 2019 and 2018, respectively, and were primarily for the payment of dividends of $6,773 and $5,557 in 2020 and 2019, respectively. In 2018, dividend payments totaled $4,350. Contractual Obligations and Off Balance Sheet Arrangements The Company has contractual obligations and commitments to make future payments under its operating leases and open purchase orders. The following schedule details these significant contractual obligations at October 2, 2020. Total Less than 1 year 2-3 years 4-5 years After 5 years Operating lease obligations $ 47,996 $ 8,025 $ 9,556 $ 8,193 $ 22,222 Open purchase orders 120,376 120,376 — — — Contractually obligated interest payments 240 113 127 — — Total contractual obligations $ 168,612 $ 128,514 $ 9,683 $ 8,193 $ 22,222 The Company utilizes letters of credit primarily as security for the payment of future claims under its workers’ compensation insurance. Letters of credit outstanding at October 2, 2020 and September 27, 2019 were $181 and $181, respectively, and were 23 Table of Contents included in the Company’s total loan availability. The Company had no unsecured revolving credit facilities at its foreign subsidiaries as of October 2, 2020 or September 27, 2019. The Company has no other off-balance sheet arrangements. The Company anticipates making contributions of approximately $171 to its defined benefit pension plans through October 2, 2020. Market Risk Management Coronavirus outbreak As disclosed in our prior filings with the Securities and Exchange Commission and elsewhere herein, in December 2019, a new strain of coronavirus ("COVID-19"), began to spread globally, leaving no region or part of the world unaffected by the pandemic it has created. Governments and health authorities have been taking, and continue to take, measures to prevent the spread of this virus, but it is presently unknown to what extent they will be successful or the potential timing of these measures and their outcome and impact on the Company's business in the future. If COVID-19 is not contained, among other things, the ability of the Company’s suppliers to manufacture and deliver the products that it sells to the Company, the ability of the Company to manufacture and deliver its products to its customers, the Company's ability to display its products at trade shows and similar events, the Company's ability to conduct meetings with its customers and prospective customers, and, if a significant number of its employees at a particular facility or location were to contract coronavirus, the Company’s ability to conduct its day-to-day operations could be adversely impacted. The financial impact of coronavirus on the Company will depend on future developments and cannot be reasonably predicted or estimated at this time, but could materially and adversely affect its results for an unknown but possibly extended period. See the section "Risk Factors" identified in Part I, Item 1A in this Form 10-K for more information. Foreign Exchange Risk The Company has significant foreign operations, for which the functional currencies are denominated primarily in euros, Swiss francs, Hong Kong dollars and Canadian dollars. As the values of the currencies of the foreign countries in which the Company has operations increase or decrease relative to the U.S. dollar, the sales, expenses, profits, losses, assets and liabilities of the Company’s foreign operations, as reported in the Company’s consolidated financial statements, increase or decrease, accordingly. Approximately 12% of the Company’s revenues for the fiscal year ended October 2, 2020 were denominated in currencies other than the U.S. dollar. Approximately 5% were denominated in euros and approximately 5% were denominated in Canadian dollars, with the remaining 2% denominated in various other foreign currencies. Changes in foreign currency exchange rates can cause unexpected financial losses or cash flow needs. Interest Rate Risk The Company operates in a seasonal business and experiences significant fluctuations in operating cash flow as working capital needs increase in advance of the Company’s primary selling and cash generation season, and decline as accounts receivable are collected and cash is accumulated. Commodities Certain components used in the Company’s products are exposed to commodity price changes. The Company manages this risk through instruments such as purchase orders and non-cancellable supply contracts. Primary commodity price exposures include costs associated with metals, resins and packaging materials. Impact of Inflation The Company anticipates that changing costs of basic raw materials may impact future operating costs and, accordingly, the prices of its products. The Company is involved in continuing programs to mitigate the impact of cost increases through changes in product design and identification of sourcing and manufacturing efficiencies. Price increases and, in certain situations, price decreases are implemented for individual products, when appropriate. The Company’s results of operations and financial condition are presented based on historical cost. The Company does not believe that inflation has significantly affected its results of operations. 24 Table of Contents Critical Accounting Estimates The Company’s management discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of its assets, liabilities, sales and expenses, and related footnote disclosures. On an on-going basis, the Company evaluates its estimates for product returns, bad debts, inventories, long lived assets and goodwill, income taxes, warranty obligations, pensions and other post-retirement benefits, litigation and other subjective matters impacting the financial statements. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. Management has discussed these policies with the Audit Committee of the Company’s Board of Directors. Allowance for Doubtful Accounts Allowances for doubtful accounts are estimated by the individual operating companies based on estimates of losses related to customer accounts receivable balances. Estimates are developed by using standard quantitative measures based on historical losses, adjusting for current economic conditions and, in some cases, evaluating specific customer accounts for risk of loss. The establishment of reserves requires the use of judgment and assumptions regarding the potential for losses on receivable balances. Though the Company considers these balances adequate and proper, changes in economic conditions in specific markets in which the Company operates and any specific customer collection issues the Company identifies could have a favorable or unfavorable effect on required reserve balances. Inventories The Company values inventory at the lower of cost (determined using the first-in first-out method) or net realizable value. Management’s judgment is required to determine the reserve for obsolete or excess inventory. Inventory on hand may exceed future demand either because the product is outdated or because the amount on hand is more than will be used to meet future needs. Inventory reserves are estimated by the individual operating companies using standard quantitative measures based on criteria established by the Company. The Company also considers current forecast plans, as well as market and industry conditions in establishing reserve levels. Though the Company considers these reserve balances to be adequate, changes in economic conditions, customer inventory levels or competitive conditions could have a favorable or unfavorable effect on required reserve balances. Deferred Taxes The Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event the Company were to determine that it would not be able to realize all or part of its net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made. Likewise, should the Company determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax assets would increase income in the period such determination was made. Goodwill and Other Intangible Assets Impairment Goodwill and indefinite-lived intangible assets are tested for impairment annually or more frequently if events or changes in circumstances indicate that the assets might be impaired. Generally, annual impairment tests are performed by the Company in the fourth quarter of each fiscal year. In assessing the recoverability of the Company’s goodwill, the Company estimates the fair value of the businesses to which the goodwill relates. Fair value is estimated using a discounted cash flow analysis. If the fair value of a reporting unit exceeds its net book value, no impairment exists. When fair value is less than the carrying value of the net assets and related goodwill, an impairment charge is recognized based on the excess of carrying amount over its fair value. The Company did not recognize any goodwill impairment charges in 2020, 2019 or 2018. 25 Table of Contents The discounted cash flow analysis used to estimate fair value requires a number of key estimates and assumptions. The Company estimates the future cash flows of the reporting units based on historical and forecasted revenues and operating costs and applies a discount rate to the estimated future cash flows for purposes of the valuation. This discount rate is based on the estimated weighted average cost of capital, which includes certain assumptions made by management such as market capital structure, market betas, the risk-free rate of return and the estimated costs of borrowing. Changes in these key estimates and assumptions, or in other assumptions used in this process, could materially affect our impairment analysis in a given year. In assessing the recoverability of the Company’s other indefinite lived intangible assets, the Company estimates the fair value of the various intangible assets. The fair value of trademarks and patents is estimated using the relief from royalty method. If the fair value of an intangible asset exceeds its net book value, no impairment exists. When fair value is less than the carrying value of the intangible asset, an impairment loss is recognized for the amount of the difference. A number of factors, many of which the Company has no ability to control, could affect its financial condition, operating results and business prospects and could cause actual results to differ from the estimates and assumptions that the Company uses in preparing its financial statements. These factors include: a prolonged global economic crisis, a significant decrease in demand for the Company’s products, a significant adverse change in legal factors or in the business climate, an adverse action or assessment by a regulator and successful efforts by the Company’s competitors to gain market share. Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of The Company evaluates long-lived assets for impairment whenever events or changes in circumstances, such as unplanned negative cash flow indicate that the carrying amount of an asset group may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to future undiscounted cash flows expected to be generated by the asset group. If such assets are determined to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Application of alternative assumptions, such as changes in the estimate of future cash flows, could produce significantly different results. Because of the significance of the judgments and estimation processes, it is likely that materially different amounts could be recorded if we used different assumptions or if the underlying circumstances were to change. Warranties The Company accrues a warranty reserve for estimated costs to provide warranty services. Warranty reserves are estimated using standard quantitative measures based on criteria established by the Company. Estimates of costs to service its warranty obligations are based on historical experience, expectation of future conditions and known product issues. To the extent the Company experiences increased warranty claim activity or increased costs associated with servicing those claims, revisions to the estimated warranty reserve would be required. The Company engages in product quality programs and processes, including monitoring and evaluating the quality of its suppliers, to help minimize warranty obligations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information with respect to this item is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading “Market Risk Management.” ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information with respect to this item is included in the Company’s consolidated financial statements attached to this report on pages F-1 to F-37. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 26 Table of Contents