Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
BUSINESS OVERVIEW
The Company is a leading global designer, marketer and licensor of branded footwear, apparel and accessories. The Company’s vision statement is “ to build a family of the most admired performance and lifestyle brands on earth ” and the Company seeks to fulfill this vision by offering innovative products and compelling brand propositions; complementing its footwear brands with strong apparel and accessories offerings; expanding its global consumer-direct footprint; and delivering supply chain excellence.
The Company’s brands are marketed in approximately 170 countries and territories at January 2, 2021, including through owned operations in the U.S., Canada, the United Kingdom and certain countries in continental Europe and Asia Pacific. In other regions (Latin America, portions of Europe and Asia Pacific, the Middle East and Africa), the Company relies on a network of third-party distributors, licensees and joint ventures. At January 2, 2021, the Company oper ated 97 re tail stores in the U.S. and Canada an d 37 co nsumer-direct eCommerce sites.
The following discussion includes a comparison of the Company's results of operations and liquidity and capital resources for fiscal 2020 and 2019. A discussion of a comparison of the Company's results of operations and liquidity and capital resources for fiscal 2019 and 2018 has been omitted from this Form 10-K but may be found in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the fiscal year ended December 28, 2019, filed with the SEC on February 26, 2020.
Impact of COVID-19
In March 2020, the World Health Organization declared the outbreak of COVID-19 a pandemic. COVID-19 has had a negative effect on the global economy and on the Company’s 2020 operating and financial results. The full financial effects of the COVID-19 pandemic cannot be reasonably estimated at this time due to uncertainty as to its severity and duration. The Company has taken the following proactive and precautionary measures to mitigate known areas of risk and navigate the future environment:
• To increase liquidity and flexibility of the Company’s capital structure, the Company borrowed $171 million in incremental 364-day term loan under its senior credit facility and by the end of the fourth quarter the amount had been repaid, and sold $300 million of 6.375% senior notes (refer to Note 7, “Debt”), delayed most capital projects, suspended share repurchases, implemented select employee furloughs and organizational changes, compensation changes for the Company's management team and Board of Directors, delayed or canceled certain future product purchases across its portfolio of brands, took additional steps to reduce discretionary spending and other expenditures, and initiated conversations with landlords to seek lease concessions. Lease concessions have been received for some of the Company’s leased properties and other discussions are still ongoing.
• The Company temporarily closed all U.S. and Canada retail stores on March 17, 2020. Stores began reopening in May under a phased approach and during the second quarter all stores had reopened with newly instituted health and safety protocols for customers and employees following regulatory guidance and protocols promulgated by health authorities and government officials. During the period stores were closed, the Company’s distribution centers remained open and the Company’s direct on-line channels continued to serve customer demand.
The COVID-19 pandemic has had, and is expected to continue to have, a material adverse impact on the Company’s financial results. Expenses related to the COVID-19 pandemic in fiscal year 2020 include $10.9 million of severance expenses, $8.5 million of credit loss expenses related to accounts receivable, $5.5 million of expenses in connection with the Company's credit facility refinance and an interest rate swap termination, $4.4 million of inventory charges, $3.9 million of air freight charges related to production delays, $3.6 million in connection with facility exit costs and $6.4 million for other costs.
The full nature and extent of the impact of the pandemic on the Company's business will depend on future developments, including, among other things; the continued spread and duration of the pandemic; the negative impact on global and regional economies and economic activity; actions governments, businesses and individuals take in response to the pandemic; the effects of the pandemic, including all of the foregoing, on the Company’s manufacturers, distributors, suppliers, joint venture partners, wholesale customers and other counterparties, and how quickly the global economy and demand for the Company's products recovers after the pandemic subsides. The Company continues to monitor the situation closely .
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2020 FINANCIAL OVERVIEW
• Revenue was $1,791.1 million for 2020, representing a decrease of 21.2% compared to the prior year's revenue of $2,273.7 million. The decrease reflects a 19.1% decline from the Michigan Group and a 23.6% decline from the Boston Group. Changes in foreign exchange rates decreased revenue by $0.5 million du ring 2020. Owned eCommerce revenue increased 49.9% during 2020 compared to 2019.
• Gross margin for 2020 was 41.1%, an increase of 50 basis points from 2019.
• The effective tax rate in 2020 was 24.7%, compared to 11.7% in 2019.
• Diluted loss per share for 2020 was $1.70, compared to a diluted earnings per share $1.44 for 2019.
• The Company declared cash dividends of $0.40 per share in 2020 and 2019.
• Cash flow provided by operating activities was $309.1 million and $222.6 million for 2020 and 2019, respectively.
• Compared to the prior year, inventory decreased $105.1 million, or 30.2%.
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RESULTS OF OPERATIONS
The following is a discussion of the Company’s results of operations and liquidity and capital resources. This section should be read in conjunction with the Company’s consolidated financial statements and related notes, which are included in Item 8 of this Annual Report on Form 10-K.
Fiscal Year
(In millions, except per share data) 2020 2019 Percent Change
Revenue
$ 1,791.1 $ 2,273.7 (21.2) %
Cost of goods sold
1,055.5 1,349.9 (21.8) %
Gross profit
735.6 923.8 (20.4) %
Selling, general and administrative expenses
639.4 669.3 (4.5) %
Impairment of intangible assets 222.2 — —
Environmental and other related costs, net of recoveries 11.1 83.5 (86.7) %
Operating profit (loss) (137.1) 171.0 (180.2) %
Interest expense, net
43.6 30.0 45.3 %
Debt extinguishment, interest rate swap termination, and other costs 5.5 — —
Other income, net (2.1) (4.9) (57.1) %
Earnings (loss) before income taxes (184.1) 145.9 (226.2) %
Income tax expense (benefit) (45.5) 17.0 (367.6) %
Net earnings (loss) (138.6) 128.9 (207.5) %
Less: net earnings (loss) attributable to noncontrolling interests (1.7) 0.4 (525.0) %
Net earnings (loss) attributable to Wolverine World Wide, Inc. $ (136.9) $ 128.5 (206.5) %
Diluted earnings (loss) per share $ (1.70) $ 1.44 (218.1) %
REVENUE
Revenue was $1,791.1 million for 2020, representing a decline of 21.2% compared to the prior year's revenue of $2,273.7 million. The change in revenue reflected a 19.1% decline from the Michigan Group and a 23.6% decline from the Boston Group. The Michigan Group's revenue decline was driven by mid-teens decline from Merrell ® , low-thirties decline from Cat ® , low-teens decline from each of Wolverine ® and Chaco ® , low-twenties decline from Bates ® , mid-thirties decline from Hytest ® , and mid-forties decline from Hush Puppies ® . The Boston Group’s revenue decline was driven by high-thirties decline from Sperry ® and high-twenties decline from each of Keds ® and Kids’. International revenue represented 31.1%, an d 33.7% of total reported revenues in 2020 and 2019 respectively. Changes in foreign exchange rates decreased revenue by $ 0.5 million during 2020. Owned eCommerce revenue increased during 2020 by 49.9% compared to 2019.
GROSS MARGIN
For 2020 , the Company’s gross margin was 41.1%, compared to 40.6% in 2019. The gross margin increase was driven by favorable product mix including higher margin eCommerce revenue (180 basis points) and favorable LIFO adjustment resulting from liquidation of historical LIFO layers from the decline in inventory (15 basis points), partially offset by lower international royalties (75 basis points), incremental tariffs (50 basis points), and higher non-operating costs due to the COVID-19 pandemic (35 basis points).
OPERATING EXPENSES
Operating expenses increased $119.9 million in 2020, to $872.7 million. The increase was driven by the impairment of intangible assets ($222.2 million), higher non-operating costs incurred due to the COVID-19 pandemic ($21.8 million), higher advertising costs ($16.2 million), and higher incentive compensation costs ($7.4 million). These increases were partially offset by lower environmental and other related costs, net of recoveries ($72.4 million), lower selling costs ($35.1 million), lower general and administrative costs ($24.4 million), lower product development costs ($10.3 million), and lower distribution costs ($5.5 million).
INTEREST, OTHER AND TAXES
Net interest expense was $43.6 million in 2020 compared to $30.0 million in 2019. Interest expense increased in the current year due to higher average debt balances in 2020.
The Company incurred a $4.9 million expense in connection with the termination of the interest rate swap and $0.6 million expense in connection with the Company's refinancing activities.
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The effective tax rate in 2020 was 24.7%, compared to 11.7% in 2019. The higher effective tax rate in 2020 reflects the positive net impact from one-time discrete items combined with a shift in income between tax jurisdictions with differing tax rates.
Other income was $2.1 million in 2020 compared to $4.9 million in 2019. The decrease was driven by higher non-service pension costs ($2.0 million) and higher losses from equity method investments ($1.3 million), partially offset by higher sublease income ($0.8 million).
REPORTABLE SEGMENTS
The Company’s portfolio of brands is organized into the following two operating segments, which the Company has determined to be reportable segments.
• Wolverine Michigan Group , consisting of Merrell ® footwear and apparel, Cat ® footwear, Wolverine ® footwear and apparel, Chaco ® footwear, Hush Puppies ® footwear and apparel, Bates ® uniform footwear, Harley-Davidson ® footwear and Hytest ® safety footwear; and
• Wolverine Boston Group , consisting of Sperry ® footwear, Saucony ® footwear and apparel, Keds ® footwear and the Kids' footwear business, which includes the Stride Rite ® licensed business, as well as Kids' footwear offerings from Saucony ® , Sperry ® , Keds ® , Merrell ® , Hush Puppies ® and Cat ® .
The Company also reports “Other” and “Corporate” categories. The Other category consists of the Company’s leather marketing operations, sourcing operations and multi-branded consumer-direct retail stores. The Corporate category consists of unallocated corporate expenses such as costs related to the COVID-19 pandemic, impairment of intangible assets and environmental and other related costs.
The reportable segment results for years 2020 and 2019 are as follows:
Fiscal Year
(In millions) 2020 2019 Change Percent Change
REVENUE
Wolverine Michigan Group $ 1,051.0 $ 1,299.7 $ (248.7) (19.1) %
Wolverine Boston Group 696.0 910.9 (214.9) (23.6) %
Other
44.1 63.1 (19.0) (30.1) %
Total
$ 1,791.1 $ 2,273.7 $ (482.6) (21.2) %
OPERATING PROFIT (LOSS)
Wolverine Michigan Group $ 179.9 $ 244.8 $ (64.9) (26.5) %
Wolverine Boston Group 88.1 153.8 (65.7) (42.7) %
Other
1.6 2.9 (1.3) (44.8) %
Corporate
(406.7) (230.5) (176.2) 76.4 %
Total
$ (137.1) $ 171.0 $ (308.1) (180.2) %
Further information regarding the reportable segments can be found in Note 18 to the consolidated financial statements.
Wolverine Michigan Group
The Michigan Group’s revenue decreased $248.7 million, or 19.1%, in 2020 compared to 2019. The decline as driven by mid-teens decline from Merrell ® , low-thirties decline from Cat ® , low-teens decline from each of Wolverine ® and Chaco ® , low-twenties decline from Bates ® , mid-thirties decline from Hytest ® , and mid-forties decline from Hush Puppies ® . The decline across all brands is due to the COVID-19 pandemic, partially offset by eCommerce growth.
The Michigan Group’s operating profit decreased $64.9 million, or 26.5%, in 2020 compared to 2019. The operating profit decline was due to the revenue declines, partially offset by a 70 basis point increase in gross margin and a $30.0 million decrease in selling, general and administrative costs. The increase in gross margin in the current year period was due improved product mix including higher margin eCommerce sales, partially offset by increased tariffs. The decrease in selling, general and administrative expenses in the current year period was due to reductions in employee costs and other discretionary spending in response to the COVID-19 pandemic.
Wolverine Boston Group
The Boston Group’s revenue decreased $214.9 million, or 23.6% , in 2020 compared to 2019. The decline was driven by high-thirties decline from Sperry ® and high-twenties decline from each of Keds ® and Kids’. The decline across all brands is due to the COVID-19 pandemic, partially offset by eCommerce growth.
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The Boston Group’s operating profit decreased $65.7 million, or 42.7%, in 2020 compared to 2019. The operating profit decline was due to the revenue declines, partially offset by a 150 basis point increase in gross margin and a $13.2 million decrease in selling, general and administrative costs. The increase in gross margin in the current year period was due improved product mix including higher margin eCommerce sales, partially offset by increased tariffs. The decrease in selling, general and administrative expenses in the current year period was due to reductions in employee costs and other discretionary spending in response to the COVID-19 pandemic.
Other
The Other category's revenue decreased $19.0 million, or 30.1%, in 2020 compared to 2019. The decline is due to high-twenties decline in the performance leathers business due to the COVID-19 pandemic.
Corporate
Corporate expens es increased $176.2 million in 2020 compared to 2019 due to the impairment of the Sperry trade name ($222.2 million) and higher non-operating costs due to the COVID-19 pandemic ($29.3 million), partially offset by lower environmental and other related costs ($72.4 million). Refer to Note 4, “Goodwill and Other Intangibles” for additional discussion on the Sperry trade name impairment.
LIQUIDITY AND CAPITAL RESOURCES
Fiscal Year
(In millions) 2020 2019
Cash and cash equivalents $ 347.4 $ 180.6
Debt 722.5 798.4
Available Revolving Credit Facility (1)
793.9 434.3
Net cash provided by operating activities 309.1 222.6
Net cash provided by (used in) investing activities 6.1 (61.5)
Net cash used in financing activities (154.0) (124.6)
Additions to property, plant and equipment 10.3 34.4
Depreciation and amortization 32.8 32.7
(1) Amounts are net of both borrowings, if any, and outstanding standby letters of credit issued in accordance with the terms of the Revolving Credit Facility.
Liquidity
Cash and cash equivalents of $347.4 million as of January 2, 2021 were $166.8 million higher compared to December 28, 2019. The increase is due primarily to cash provided by operating activities of $309.1 million, cash provided by investing activities of $6.1 million, partially offset by net repayments of debt of $72.5 million, cash dividends paid of $33.6 million, share repurchases of $21.0 million, and shares acquired related to employee stock plans of $24.8 million. The Company had $793.9 million of borrowing capacity available under the Revolving Credit Facility as of January 2, 2021. Cash and cash equivalents located in foreign jurisdictions totaled $125.7 million as of January 2, 2021.
Cash flow from operating activities, along with the Revolving Credit Facility capacity, are expected to be sufficient to meet the Company’s working capital needs for the foreseeable future. Any excess cash flow from operating activities is expected to be used to fund organic growth initiatives, reduce debt, and pay dividends.
A detailed discussion of environmental remediation costs is found in Note 17 to the Company's Consolidated Financial Statements. The Company has established a reserve for estimated environmental remediation costs based upon an evaluation of currently available facts with respect to each individual affected site. As of January 2, 2021, the Company has a reserve of $101.8 million, of which $23.6 million is expected to be paid in the next 12 months and is recorded as a current obligation in other accrued liabilities, with the remaining $78.2 million recorded in other liabilities and expected to be paid over the course of up to 25 years. The Company's remediation activity at its former Tannery site and sites where the Company disposed of Tannery byproducts is ongoing. It is difficult to estimate the cost of environmental compliance and remediation given the uncertainties regarding the interpretation and enforcement of applicable environmental laws and regulations, the extent of environmental contamination and the existence of alternative cleanup methods. Future developments may occur that could materially change the Company’s current cost estimates. The Company adjusts recorded liabilities as further information develops or circumstances change.
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Operating Activities
The principal source of the Company’s operating cash flow is net earnings, including cash receipts from the sale of the Company’s products, net of costs of goods sold.
Cash from operations during 2020 was higher compared to 2019, due primarily to a decrease in net working capital representing a source of cash of $187.9 million. Working capital balances were favorably impacted by a decrease in inventories of $107.2 million, a decrease in accounts receivable of $64.8 million, an increase in other operating liabilities of $27.9 million, and a decrease in other operating assets of $7.4 million, partially offset by a decrease in accounts payable of $18.9 million. Operating cash flows were favorably impacted by Environmental and other related costs, net of cash payments and recoveries received, of $31.5 million, which included $55.0 million paid by 3M Company during the first quarter of 2020. See Note 17 for additional information regarding this settlement payment.
Investing Activities
The Company made capital expenditures of $10.3 million and $34.4 million in years 2020 and 2019 respectively, for building improvements, new retail stores and information system enhancements. Capital expenditures were lower in 2020 compared to 2019 due to reductions in non-essential capital spending in response to the COVID-19 pandemic.
The Company made a cash investment of $3.5 million and $8.5 million in joint ventures in years 2020 and 2019 respectively. The Company made a contingent consideration payment of $5.5 million during 2020 related to the Saucony ® Italy distributor acquisition. The Company's initial cash payment for the business acquisition was $15.1 million paid in 2019. See Note 19 for additional information regarding the acquisition. The Company received proceeds of $26.8 million from company-owned life insurance policy liquidations.
Financing Activities
On May 5, 2020, the Company entered into a Second Amendment to its senior credit facility. In connection with the Second Amendment, the Company borrowed an incremental $171.0 million in aggregate principal in Incremental Term Loan. The Incremental Term Loan was repaid in full by the end of fiscal 2020. The Amended Senior Credit Facility also includes a $200.0 million term loan facility and a $800.0 million Revolving Credit Facility, both with maturity dates of December 6, 2023, that remain unchanged as a result of the Second Amendment. The Amended Senior Credit Facility’s debt capacity is limited to an aggregate debt amount (including outstanding term loan principal and revolver commitment amounts in addition to permitted incremental debt) not to exceed $1,750.0 million, unless certain specified conditions set forth in the Amended Senior Credit Facility are met. Term Loan A requires quarterly principal payments with a balloon payment due on December 6, 2023
The Revolving Credit Facility allows the Company to borrow up to an aggregate amount of $800.0 million, which includes a $200.0 million foreign currency subfacility under which borrowings may be made, subject to certain conditions, in Canadian dollars, British pounds, euros, Hong Kong dollars, Swedish kronor, Swiss francs and such additional currencies as are determined in accordance with the Credit Agreement. The Revolving Credit Facility also includes a $50.0 million swingline subfacility and a $50.0 million letter of credit subfacility. The Company had no outstanding borrowings under the Revolving Credit Facility and outstanding letters of credit under the Revolving Credit Facility of $6.1 million as of January 2, 2021. The outstanding letters of credit reduce the borrowing capacity under the Revolving Credit Facility.
On May 11, 2020, the Company issued $300.0 million aggregate principal amount of 6.375% senior notes due on May 15, 2025 related interest payments are due semi-annually beginning on November 15, 2020. These senior notes are guaranteed by substantially all of the Company’s domestic subsidiaries.
As of January 2, 2021, the Company was in compliance with all covenants and performance ratios under the Credit Agreement.
The Company’s debt at January 2, 2021 totaled $722.5 million, compared to $798.4 million at December 28, 2019. The decrease was due to repayments on the Revolving Credit Facility of $360.0 million and scheduled principal payments on Term Loan A of $12.5 million, partially offset by the $300.0 million 6.375% senior notes issued.
The Company has a foreign revolving credit facility with aggregate available borrowin gs of $4.0 million that are uncommitted and, therefore, each borrowing against the applicable facility is subject to approval by the lender. There were no borrowings against this facility at January 2, 2021.
The Company repurchased $21.0 million and $319.2 million of Company common stock in years 2020 and 2019 respectively, under stock repurchase plans. The Company may purchase up to an additional $487.4 million of shares under its existing stock repurchase program which expires in 2023. As part of its strategy to increase liquidity and the flexibility of the Company’s capital structure as a result of the COVID-19 pandemic, the Company temporarily suspended share repurchases in March 2020. In addition to the stock repurchase program activity, the Company acquired $24.8 million and $16.9 million of shares in years
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2020 and 2019 respectively, in connection with shares or units withheld to pay employee taxes related to stock-based compensation plans.
The Company declared cash dividends of $0.40 per share for each of fiscal 2020 and 2019. Dividends paid totaled $33.6 million and $33.6 million for 2020 and 2019, respectively. A quarterly dividend of $0.10 per share was declared on February 9, 2021 to shareholders of record on April 1, 2021.
NEW ACCOUNTING STANDARDS
See Note 2 to the Company's Consolidated Financial Statements for information related to new accounting standards.
CRITICAL ACCOUNTING POLICIES
The preparation of the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. ("U.S. GAAP"), requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. On an ongoing basis, management evaluates these estimates. Estimates are based 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. Historically, actual results have not been materially different from the Company’s estimates. However, actual results may differ materially from these estimates under different assumptions or conditions.
The Company has identified the following critical accounting policies used in determining estimates and assumptions in the amounts reported. Management believes that an understanding of these policies is important to an overall understanding of the Company’s consolidated financial statements.
Revenue Recognition and Performance Obligations
Revenue is recognized upon the transfer of promised goods or services to customers, in an amount that reflects the expected consideration to be received in exchange for those goods or services. The Company identifies the performance obligation in the contract, determines the transaction price, allocates the transaction price to the performance obligations, and recognizes revenue upon completion of the performance obligation. Revenue is recognized net of variable consideration and any taxes collected from customers, which are subsequently remitted to governmental authorities.
Control of the Company's goods and services, and associated revenue, are transferred to customers at a point in time. The Company’s contract revenue consist of wholesale revenue and consumer-direct revenue. Wholesale revenue is recognized for products sourced by the Company when control transfers to the customer generally occurring upon the purchase, shipment or delivery of branded products or to the customer. Consumer-direct includes eCommerce revenue that is recognized for products sourced by the Company when control transfers to the customer once the related goods have been shipped and retail store revenue recognized at time of sale. The point of purchase or shipment was evaluated to best represent when control transfers based on the Company’s right of payment for the goods, the customer’s legal title to the asset, the transfer of physical possession and the customer having the risks and rewards of the goods. Payment terms for the Company's revenue vary by sales channel. Standard credit terms apply to the Company's wholesale receivables, while payment is rendered at the time of sale within the consumer-direct channel.
Revenue is recorded at the net sales price (“transaction price”), which includes estimates of variable consideration for which reserves are established. Components of variable consideration include trade discounts and allowances, product returns, customer markdowns, customer rebates and other sales incentives relating to the sale of the Company’s products. These reserves are based on the amounts earned, or to be claimed on the related sales. These estimates take into consideration a range of possible outcomes, which are probability-weighted in accordance with the expected value method for relevant factors such as current contractual and statutory requirements, specific known market events and trends, industry data and forecasted customer buying and payment patterns. Overall, these reserves reflect the Company’s best estimates of the amount of consideration to which it is entitled based on the terms of the respective underlying contracts. Revenue recognized during the year ended January 2, 2021, related to the Company’s contract liabilities, was nominal.
Allowance for Credit Losses
The Company maintains an allowance for credit losses on accounts receivable that represents estimated losses resulting from its customers’ failure to make required payments. Company management evaluates the allowance for credit losses based on a review of current customer status and historical collection experience along with current and reasonable supportable forecasts of future economic conditions.
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Inventory
The Company values its inventory at the lower of cost or net realizable value. Cost is determined by the last-in, first out ("LIFO") method for certain domestic finished goods inventories. Cost is determined using the first-in, first-out (“FIFO”) method for all raw materials, work-in-process and finished goods inventories in foreign countries and certain domestic finished goods inventories. The average cost of inventory is used for finished goods inventories of the Company’s consumer-direct business. The Company has applied these inventory cost valuation methods consistently from year to year.
The Company reduces the carrying value of its inventories to the lower of cost or net realizable value for excess or obsolete inventories based upon assumptions about future demand and market conditions. If the Company were to determine that the estimated realizable value of its inventory is less than the carrying value of such inventory, the Company would provide a reserve for such difference as a charge to cost of sales. If actual market conditions are different from those projected, adjustments to those inventory reserves may be required. The adjustments would increase or decrease the Company’s cost of sales and net income in the period in which they were realized or recorded. Inventory quantities are verified at various times throughout the year by performing physical inventory counts and subsequently comparing those results to perpetual inventory balances. If the Company determines that adjustments to the inventory quantities are appropriate, an adjustment to the Company’s cost of goods sold and inventory is recorded in the period in which such determination was made.
Goodwill and Indefinite-Lived Intangibles
Goodwill and intangible assets deemed to have indefinite lives are not amortized, but are subject to impairment tests at least annually. The Company reviews the carrying amounts of goodwill and indefinite-lived intangible assets by reporting unit at least annually, or when indicators of impairment are present, to determine if such assets may be impaired. If the carrying amounts of these assets are not recoverable based upon discounted cash flow and market approach analyses, the carrying amounts of such assets are reduced by the estimated difference between the carrying values and estimated fair values. The Company includes assumptions about expected future operating performance as part of a discounted cash flow analysis to estimate fair value.
For goodwill, if the estimated fair value of the reporting unit exceeds its carrying value, no further review is required. However, if the estimated fair value of the reporting unit is less than its carrying value, the Company records an impairment charge equal to the excess of the recorded goodwill over the fair value of the goodwill.
The Company may first assess qualitative factors to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying value. The Company would not be required to quantitatively determine the fair value of the indefinite-lived intangible unless the Company determines, based on the qualitative assessment, that it is more likely than not that its fair value is less than the carrying value. Future cash flows of the individual indefinite-lived intangible assets are used to measure their fair value after consideration by management of certain assumptions, such as forecasted growth rates and cost of capital, which are derived from internal projections and operating plans.
The Company performs its annual testing for goodwill and indefinite-lived intangible asset impairment at the beginning of the fourth quarter of the year for all reporting units. The Company did not recognize any impairment charges for goodwill during years 2020, 2019 and 2018. No impairment charges were recognized for the Company's intangible assets during years 2019 and 2018. In the fourth quarter of 2020, after the completion of the annual impairment testing, the Company recorded a $222.2 million impairment charge for the Sperry trade name. Refer to Note 4, “Goodwill and Other Intangibles” for additional discussion on the Sperry trade name impairment.
Impairment of Long-Lived Assets
The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or an asset group may not be recoverable. Each impairment test is based on a comparison of the carrying amount of the asset or asset group to the future undiscounted net cash flows expected to be generated by the asset or asset group. If such assets are considered to be impaired, the impairment amount to be recognized is the amount by which the carrying value of the assets exceeds their fair value. No impairment charges were recognized for the Company's long-lived assets during years 2020, 2019 and 2018.
Environmental
The Company establishes a reserve for estimated environmental remediation costs based upon the evaluation of currently-available facts with respect to each individual affected site. The costs are recorded on an undiscounted basis when they are probable and reasonably estimable, generally no later than the completion of feasibility studies, the Company’s commitment to a plan of action, or approval by regulatory agencies. Liabilities for estimated costs of environmental remediation are based primarily upon third-party environmental studies, other internal analysis and the extent of the contamination and the nature of required remedial actions at each site. The Company records adjustments to the estimated costs if there are changes in the scope
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of the required remediation activity, extent of contamination, governmental regulations or remediation technologies. Environmental costs relating to existing conditions caused by past operations that do not contribute to current or future revenues are expensed as incurred. Refer to Note 17, “Litigation and Contingencies” for additional discussion on estimated environmental remediation costs.
Assets related to potential recoveries from other responsible parties are recognized when a definitive agreement is reached and collection of cash is realizable. Recoveries of covered losses under insurance policies are recognized only when realization of the claim is deemed realized or realizable.
Retirement Benefits
The determination of the obligation and expense for retirement benefits depends upon the selection of certain actuarial assumptions used in calculating such amounts. These assumptions include, among others, the discount rate, expected long-term rate of return on plan assets, mortality rates and rates of increase in compensation. These assumptions are reviewed with the Company’s actuaries and updated annually based on relevant external and internal factors and information, including, but not limited to, long-term expected asset returns, rates of termination, regulatory requirements and plan changes.
The Company utilizes a bond matching calculation to determine the discount rate used to calculate its year-end pension liability and subsequent year pension expense. A hypothetical bond portfolio is created based on a presumed purchase of individual bonds to settle the plans' expected future benefit payments. The discount rate is the resulting yield of the hypothetical bond portfolio. The bonds selected are listed as high grade by at least two recognized ratings agency and are non-callable, currently purchasable and non-prepayable. The calculated discount rate was 2.85% at January 2, 2021, compared to 3.60% at December 28, 2019. Pension expense is also impacted by the expected long-term rate of return on plan assets, which the Company has determined to be 6.75% for both fiscal 2020 and 2019. This rate is based on both actual historical rates of return experienced by the pension assets and the long-term rate of return of a composite portfolio of equity and fixed income securities that reflects the approximate diversification of the pension assets.
Income Taxes
The Company maintains certain strategic management and operational activities in overseas subsidiaries, and its foreign earnings are taxed at rates that have generally been lower than the U.S. federal statutory income tax rate. A significant amount of the Company’s earnings are generated by its Canadian, European and Asian subsidiaries and, to a lesser extent, in jurisdictions that are not subject to income tax. Income tax audits associated with the allocation of this income and other complex issues may require an extended period of time to resolve and may result in income tax adjustments if changes to the income allocation are required between jurisdictions with different income tax rates. Because income tax adjustments in certain jurisdictions can be significant, the Company records accruals representing management’s best estimate of the resolution of these matters. To the extent additional information becomes available, such accruals are adjusted to reflect the revised estimated outcome. The carrying value of the Company’s deferred tax assets assumes that the Company will be able to generate sufficient taxable income in future years to utilize these deferred tax assets. If these assumptions change, the Company may be required to record valuation allowances against its gross deferred tax assets in future years, which would cause the Company to record additional income tax expense in its consolidated statements of operations. Management evaluates the potential that the Company will be able to realize its gross deferred tax assets and assesses the need for valuation allowances on a quarterly basis.
On a periodic basis, the Company estimates the full year effective tax rate and records a quarterly income tax provision in accordance with the projected full year rate. As the year progresses, that estimate is refined based upon actual events and the distribution of earnings in each tax jurisdiction during the year. This continual estimation process periodically results in a change to the expected effective tax rate for the year. When this occurs, the Company adjusts the income tax provision during the quarter in which the change in estimate occurs so that the year-to-date provision reflects the revised anticipated annual rate.
The Company intends to repatriate cash held in foreign jurisdictions and has recorded a deferred tax liability related to estimated state taxes and foreign withholding taxes on the future dividends received in the U.S. from the foreign subsidiaries.
The Company intends to permanently reinvest all non-cash undistributed earnings outside of the U.S. and has, therefore not established a deferred tax liability on that amount of foreign unremitted earnings. However, if these non-cash undistributed earnings were repatriated, the Company would be required to accrue and pay applicable U.S. taxes and withholding taxes payable to various countries. It is not practicable to estimate the amount of the deferred tax liability associated with these non-cash unremitted earnings due to the complexity of the hypothetical calculation.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has no off-balance sheet arrangements as of January 2, 2021.
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CONTRACTUAL OBLIGATIONS
As of January 2, 2021, the Company had the following payments under contractual obligations due by period:
(In millions) Total Less than
1 year 1-3 years 3-5 years More than
5 years
Long-term debt obligations (1)
$ 899.6 $ 46.9 $ 242.9 $ 351.5 $ 258.3
Operating lease obligations
211.1 33.9 51.2 35.8 90.2
Purchase obligations (2)
550.6 550.6 — — —
Supplemental Executive Retirement Plan
42.2 3.8 8.0 8.3 22.1
Deferred compensation
1.6 0.4 0.8 0.3 0.1
Dividends declared
8.3 8.3 — — —
Municipal water improvements (3)
59.8 13.2 46.6 — —
TCJA transition obligation
27.9 0.2 16.1 11.6 —
Minimum royalties
3.5 1.7 1.8 — —
Minimum advertising
13.8 3.3 6.9 3.6 —
Total (4)
$ 1,818.4 $ 662.3 $ 374.3 $ 411.1 $ 370.7
(1) Includes principal and interest payments on the Company’s long-term debt. Estimated future interest payments on outstanding debt obligations are based on interest rates as of January 2, 2021. Actual cash outflows may differ significantly due to changes in underlying interest rates.
(2) Purchase obligations related primarily to inventory and capital expenditure commitments.
(3) Under the terms of the approved Consent Decree, the Company is obligated to contribute towards the costs of extending municipal water lines, developing a replacement wellfield and making certain improvements to Plainfield Township’s existing water treatment plant, all subject to an aggregate cap of $69.5 million. During 2020, the Company made payments of $9.7 million towards the total cap. Due to the uncertainty of the timing and amounts related to the Company's other environmental remediation costs, they have been excluded from this table. See Note 17 to the Company's Consolidated Financial Statements for additional information.
(4) The total amount of unrecognized tax benefits on the consolidated balance sheet at January 2, 2021 is $5.5 million. At this time, the Company is unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing of tax audit outcomes. As a result, this amount is not included in the table above.