# ROCKY BRANDS, INC. (RCKY) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from ROCKY BRANDS, INC.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/895456/000143774924007987/rcky20231231_10k.htm
Accession: 0001437749-24-007987
Filing date: 2024-03-15
Report date: 2023-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/RCKY/
All MD&A years: /company/RCKY/mda/
Previous year: /company/RCKY/mda/fy2022/ (FY 2022)
Next year: /company/RCKY/mda/fy2024/ (FY 2024)

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

This Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") describes the matters that we consider to be important to understanding the results of our operations for each of the two years in the period ended December 31, 2023 and 2022, and our capital resources and liquidity as of December 31, 2023 and 2022. For the discussion of the changes in our results of operations between the years ended December 31, 2022 and December 31, 2021, refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations", of our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC on March 10, 2023, which is available on the SEC's website at https://www.sec.gov/edgar/search/ and our corporate website at www.rockybrands.com. We analyze the results of our operations for the last two years (including trends in the overall business), followed by a discussion of our cash flows and liquidity, our credit facilities, and our contractual commitments. We then provide a review of the critical accounting policies and estimates we have made that we believe are most important to the understanding of our MD&A and our Consolidated Financial Statements. We conclude our MD&A with information on recent accounting pronouncements which we adopted during the year, as well as those not yet adopted that are expected to have an impact on our financial accounting practices.

The following discussion should be read in conjunction with our Consolidated Financial Statements and the notes thereto, included elsewhere herein. The forward-looking statements in this section and other parts of this Annual Report on Form 10-K involve risks and uncertainties including statements regarding our plans, objectives, goals, strategies and financial performance. Our actual results could differ materially from the results anticipated in these forward-looking statements as a result of factors set forth under the caption "Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995" below. The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements made by or on behalf of the Company.

18

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BUSINESS OVERVIEW

We are a leading designer, manufacturer and marketer of premium quality footwear and apparel marketed under a portfolio of well recognized brand names including Rocky, Muck, Georgia Boot, Durango, XTRATUF, Lehigh, Ranger and the licensed brand Michelin. 

Our brands have a long history of representing high quality, comfortable, functional, and durable footwear, and our products are organized around six target markets: outdoor, work, duty, commercial military, military and western. Our footwear products incorporate varying features and are positioned across a range of suggested retail price points from 
$45.00 for our value priced products to
$655.00 for our premium products. As a part of our strategy of outfitting consumers from head-to-toe, we market complementary branded apparel and accessories that we believe leverage the strength and positioning of each of our brands.

Our products are distributed through three distinct business segments: Wholesale, Retail and Contract Manufacturing. In our Wholesale business, we distribute our products through a wide range of distribution channels representing over 10,000 retail store locations in the U.S., Canada, U.K., and other international markets such as Europe. Our Wholesale channels vary by product line and include sporting goods stores, outdoor retailers, independent shoe retailers, hardware stores, catalogs, mass merchants, uniform stores, farm store chains, specialty safety stores, specialty retailers, and online retailers. Our Retail business includes direct sales of our products to consumers through our business-to-business web platform, e-commerce websites, third-party marketplaces and our Rocky Outdoor Gear Store. Our Contract Manufacturing segment includes sales to the U.S. Military, private label sales and any sales to customers in which we are contracted to manufacture or source a specific footwear product for a customer. 

During the first quarter of 2023, we divested the Servus brand. The gain of approximately $1.3 million on the sale of the Servus brand during the first quarter was recorded within Interest Expense and Other - net in the Consolidated Statements of Operations for the year ended December 31, 2023. The Servus brand was sold to allow us to focus on our more profitable core brands and allocate resources toward growth and development of additional opportunities with those brands moving forward. 

During the third quarter of 2023, we closed our manufacturing facility in Rock Island, Illinois. Acquired in March of 2021 as a part of our acquisition of the performance and lifestyle footwear business of Honeywell International Inc, this facility primarily manufactured product for the Servus brand. Following the sale of the Servus brand in the first quarter of 2023, the Rock Island facility was underutilized, prompting our decision to close the facility during the third quarter of 2023.

In 2023, we were also awarded a new multi-year contract with the U.S. Military pursuant to which we will produce and ship a minimum number of pairs to the U.S. Military through 2026, with an option to extend. The sales under this contract are included in our Contract Manufacturing segment.

We completed the sale of the NEOS brand during the third quarter of 2022. The sale of NEOS inventory was recorded within net sales and cost of goods sold within the Consolidated Statements of Operations for the year ended December 31, 2022. The gain on sale of the NEOS assets is recorded as a reduction of operating expenses within the Consolidated Statements of Operations for the year ended December 31, 2022.

ECONOMIC CONDITIONS AND UNCERTAINTIES

Our growth strategy is founded substantially on the expansion of our brands into new footwear and apparel markets. New products that we introduce may not be successful with consumers or one or more of our brands may fall out of favor with consumers. If we are unable to anticipate, identify or react appropriately to changes in consumer preferences, we may not grow as fast as we plan to grow, or our sales may decline, and our brand image and operating performance may suffer.

Furthermore, achieving market acceptance for new products will likely require us to exert substantial product development and marketing efforts, which could result in a material increase in our operating expenses to which there can be no assurance that we will have the resources necessary to undertake such efforts. Material increases in our operating expenses could adversely impact our results of operations and cash flows.

We may also encounter difficulties in producing new products that we did not anticipate during the development stage. Our development schedules for new products are difficult to predict and are subject to change as a result of shifting priorities in response to consumer preferences and competing products. If we are not able to efficiently manufacture newly developed products in quantities sufficient to support retail distribution, we may not be able to recoup our investment in the development of new products. Failure to gain market acceptance for new products that we introduce could impede our growth, reduce our profits, adversely affect the image of our brands, erode our competitive position, and result in long term harm to our business.

As the macroeconomic environment is continuously evolving, we are aware that global trends, such as inflationary pressures, are weakening consumer sentiment, negatively impacting consumer spending, and creating differing traffic patterns across channels. These conditions have led to elevated inventory levels in certain markets and an increased promotional environment. We have also experienced higher interest rates which have resulted in increased borrowing costs. There is ongoing uncertainty surrounding the global economy and macroeconomic environment, which we expect to continue and could potentially cause disruption and near-term challenges for our business.

We continue to monitor pressures on the global supply chain, which have shifted the timing of shipments across our brands, resulting in increased inventory levels outpacing our sales growth. However, we have seen improvements in transit lead times and related freight costs compared to the prior period, which have had a positive impact on the results of our operations through 2023.

2023 FINANCIAL OVERVIEW

[[GREPCENT_TABLE]]
[["\u25cf","Net sales decreased 25.0% to $461.8 million"],["\u25cf","Gross margin increased 210 basis points to 38.7%"],["\u25cf","Operating income decreased 19.7% to $35.4 million"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["\u25cf","Net income decreased 49.1% to $10.4 million, or $1.41 per diluted share"],["\u25cf","Total debt, net of debt issuance costs, decreased 32.6% to $173.1 million"]]
[[/GREPCENT_TABLE]]

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[[GREPCENT_TABLE]]
[["\u25cf","Inventory decreased 28.1% to $169.2 million"],["\u25cf","Cash provided by operating activities increased 285% to $54.5 million"]]
[[/GREPCENT_TABLE]]

We experienced a decline in sales of 25.0% to $461.8 million for the year ending December 31, 2023 compared to the year ending December 31, 2022, primarily attributable to our Wholesale segment. The sales decline in our Wholesale segment was due to a challenging macroeconomic environment, coupled with our wholesale partners working through excess inventories. Additionally, distribution challenges in 2021 led to delayed delivery of Fall 2021 inventory into the first half of 2022, creating a difficult year-over-year comparison for the first nine months of 2023. While our 2023 performance was challenged by a difficult macroeconomic backdrop and a tough year-over-year comparison for our Wholesale segment, we experienced strong retail sell-through and increased performance of our own e-commerce websites, which partially offset the decrease in Wholesale sales. 

During the year ending December 31, 2023, our gross margin improved 210 basis points to 38.7%. The increase in gross margin for the year ending December 31, 2023 compared to the year ending December 31, 2022 was due to several factors. First, higher Wholesale segment gross margins resulted from the realization of pricing actions taken the second half of 2022 and a reduction in inbound logistics costs. Secondly, a greater proportion of Retail segment sales, which carry higher gross margins than our Wholesale and Contract Manufacturing segments, also contributed to the increase.

Operating income decreased to $35.4 million in 2023. As a percentage of net sales, operating income was 7.7% in 2023 compared to 7.2% in 2022. The increase in operating income as a percentage of net sales was attributed to reorganization changes made during 2023 in an effort to leverage top-line sales and decrease operating expenses. As a percentage of net sales, our gross margin increased 210 basis points year over year while operating expenses only increased 160 basis points. The overall increase in operating expenses as a percentage of net sales for full year 2023, when compared to the year ago period, was attributable to costs incurred prior to realizing the benefits from cost-savings reviews and operational efficiencies implemented by management through strategic initiatives, particularly in the first half of 2023. This was partially offset by lower variable costs associated with lower net sales. Additionally, operating expenses as a percentage of net sales decreased in the latter half of 2023 compared to the same period a year ago.

As of December 31, 2023 we held $4.5 million in cash and cash equivalents and our total indebtedness stood at $173.1 million, a reduction of $84.6 million or 32.6% when compared to December 31, 2022. Of total debt paydown, $40.8 million of this reduction in indebtedness occurred in the fourth quarter of 2023. This created a reduction in interest expense in the fourth quarter of 2023 over the prior period for the first time since incurring our debt, despite increased interest rates on both of our credit facilities. 

The reduction in indebtedness was attributable to our strategic efforts to optimize inventory levels. At the end of the fourth quarter, inventories totaled $169.2 million, reflecting a decrease of $66.2 million or 28.1% compared to $235.4 million a year ago.

Our business generated cash flows from operations of $73.6 million for the year ending December 31, 2023, an increase of 285%, from $19.1 million of cash flows from operations generated for the year ending December 31, 2022. The 2023 cash flow from operations was primarily attributable to strategic inventory management, and improved collections on outstanding accounts receivable, partially offset by payments on our accounts payable. In terms of cash flows from investing activities, we generated $17.3 million from the sale of the Servus brand, partially offset by $3.9 million in fixed assets purchases. As noted above, cash used for financing activities included an $84.6 million debt paydown and $4.6 million dividend payment to our shareholders.

Despite facing challenges in 2023 due to a challenging macroeconomic backdrop and elevated inventory levels at several Wholesale partners, we believe the underlying fundamentals of our business and brand portfolio remain robust. Operationally and financially, we believe we are well-positioned to make strategic investments in growth in future years. Throughout 2023, our reported results showed improvement, driven by strong sell-through of our products, and ongoing improvements to overall inventory levels at the majority of our wholesale accounts, positively influencing our sell-in. Our focus on product innovation, brand building, consumer connections and fulfillment capabilities, has continued to strengthen with these efforts starting to yield positive results in the second half of 2023. 

Analysis of Results of Operations 

The following table sets forth consolidated statements of operations data as percentages of total net sales:

[[GREPCENT_TABLE]]
[["","","Twelve Months Ended"],["","","December 31,"],["","","2023","","","2022"],["NET SALES:","","","100.0","%","","","100.0","%"],["Cost of goods sold","","","61.3","","","","63.4"],["Gross margin","","","38.7","","","","36.6"],["Operating expenses","","","31.0","","","","29.4"],["Income from operations","","","7.7","%","","","7.2","%"]]
[[/GREPCENT_TABLE]]

Gross margin in 2023 was $178.6 million, or 38.7% of net sales, compared to $225.2 million, or 36.6% of net sales, in 2022. The 210-basis point improvement was driven primarily by a 150-basis point improvement in Wholesale segment gross margins combined with a higher mix of Retail segment sales, which carry higher gross margins than the Wholesale and Contract Manufacturing segments. Operating expenses were $143.2 million, or 31.0% of net sales, in 2023 compared to $181.2 million, or 29.4% of net sales, in 2022. Net sales were slightly deleveraged in 2023 due to the divestures of our Servus and NEOS brands as well as elevated inventory levels at our retail partners within our Wholesale channel, resulting in a higher percentage of operating expenses of net sales in 2023 compared to 2022. Income from operations in 2023 was $35.4 million, or 7.7% of net sales, compared to $44.0 million, or 7.2% of net sales, in 2022. This increase was due to the increases in gross margin as a percentage of net sales noted above.

[[GREPCENT_TABLE]]
[["","","Twelve Months Ended"],["","","December 31,"],["($ in thousands)","","2023","","","2022","","","Inc./ (Dec.)","","","Inc./ (Dec.)"],["NET SALES:"],["Wholesale","","$","337,019","","","$","484,779","","","$","(147,760",")","","","(30.5",")%"],["Retail","","","116,960","","","","115,354","","","","1,606","","","","1.4"],["Contract Manufacturing","","","7,854","","","","15,342","","","","(7,488",")","","","(48.8",")"],["Total Net Sales","","$","461,833","","","$","615,475","","","$","(153,642",")","","","(25.0",")%"]]
[[/GREPCENT_TABLE]]

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The decrease in Wholesale sales for the twelve months ended December 31, 2023 was due to elevated inventory levels at our retail partners within our Wholesale channel and a softer demand environment compared to the year ago period. Furthermore, the twelve months ended December 31, 2023 included only three months of net sales from the Servus brand, which was divested in the first quarter of 2023 (Note 4), compared to the year ago period including twelve months of net sales from the Servus brand and nine months of net sales from the NEOS brand, which was divested in the third quarter of 2022 (Note 5).

Retail net sales for the twelve months ended December 31, 2023 increased due to strong growth in our direct-to-consumer e-commerce business. We have enhanced our targeted marketing efforts, primarily through digital marketing, allowing us to increase brand awareness and engage more directly with consumers, which led to increased traffic on our branded websites throughout the year.

The decrease in Contract Manufacturing sales for the twelve months ended December 31, 2023 compared to the twelve months ended December 31, 2022 was due to the expiration of certain contracts with the U.S. Military. 

[[GREPCENT_TABLE]]
[["","","Twelve Months Ended"],["","","December 31,"],["($ in thousands)","","2023","","","2022","","","Inc./ (Dec.)"],["GROSS MARGIN:"],["Wholesale Margin $'s","","$","119,485","","","$","165,059","","","$","(45,574",")"],["Margin %","","","35.5","%","","","34.0","%","","","1.5","%"],["Retail Margin $'s","","$","58,391","","","$","57,817","","","$","574"],["Margin %","","","49.9","%","","","50.1","%","","","(0.2",")%"],["Contract Manufacturing Margin $'s","","$","722","","","$","2,343","","","$","(1,621",")"],["Margin %","","","9.2","%","","","15.3","%","","","(6.1",")%"],["Total Margin $'s","","$","178,598","","","$","225,219","","","$","(46,621",")"],["Margin %","","","38.7","%","","","36.6","%","","","2.1","%"]]
[[/GREPCENT_TABLE]]

The increase in Wholesale gross margin as a percentage of net sales for the twelve months ended December 31, 2023 compared to the year ago period was due to realization of pricing actions taken in 2022, as well as lower in-bound logistics costs compared to the year ago period. 

Retail gross margins as a percentage of net sales decreased slightly for the twelve months ended December 31,
2023
 compared to the same period a year ago primarily due to the Lehigh business accounting for a larger percentage of Retail sales which carries lower margins.

Contract Manufacturing gross margin as a percentage of net sales decreased for the twelve months ended
2023
compared to
2022
due to certain private label contracts that carried lower margins. 

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[[GREPCENT_TABLE]]
[["","","Twelve Months Ended"],["","","December 31,"],["($ in thousands)","","2023","","","2022","","","Inc./ (Dec.)","","","Inc./ (Dec.)"],["OPERATING EXPENSES:"],["Operating Expenses","","$","143,226","","","$","181,181","","","$","(37,955",")","","","(20.9",")%"],["% of Net Sales","","","31.0","%","","","29.4","%","","","1.6","%"]]
[[/GREPCENT_TABLE]]

The reduction in operating expenses for the twelve months ending December 31, 2023 was driven by lower out-bound freight expense and other variable expenses stemming from decreased sales volumes. In addition, the decrease in operating expenses was primarily attributable to cost saving reviews and operational efficiencies achieved through strategic restructuring initiatives implemented over the past year.

[[GREPCENT_TABLE]]
[["","","Twelve Months Ended"],["","","December 31,"],["($ in thousands)","","2023","","","2022","","","Inc./ (Dec.)","","","Inc./ (Dec.)"],["INTEREST EXPENSE AND OTHER - NET:"],["Other (Expense) Income","","$","(21,218",")","","$","(18,270",")","","$","(2,948",")","","","16.1","%"]]
[[/GREPCENT_TABLE]]

The increase in other expenses is due to an increase in interest rates on the senior term loan and credit facility, partially offset by lower debt levels in 2023 compared with 2022. Additionally, the gain of $1.3 million on the sale of the Servus brand that occurred in the first quarter of 2023 partially offset this increase. 

[[GREPCENT_TABLE]]
[["","","Twelve Months Ended"],["","","December 31,"],["($ in thousands)","","2023","","","2022","","","Inc./ (Dec.)","","","Inc./ (Dec.)"],["INCOME TAXES:"],["Income Tax (Benefit) Expense","","$","3,728","","","$","5,303","","","$","(1,575",")","","","(29.7",")%"],["Effective Tax Rate","","","26.3","%","","","20.6","%","","","5.7","%"]]
[[/GREPCENT_TABLE]]

The increase in our effective tax rate for the twelve months ended December 31, 2023 compared to the same year ago period was driven primarily by a return to provision adjustment resulting from foreign tax credits recognized in the fourth quarter of 2023.

LIQUIDITY AND CAPITAL RESOURCES

Overview

Our principal sources of liquidity have been our income from operations, cash provided by operating activities and borrowings under our credit facilities.

Over the last several years, our principal uses of cash have been for working capital and capital expenditures to support our growth, as well as dividend payments. Our working capital consists primarily of trade receivables and inventory, offset by accounts payable and accrued expenses. Our working capital fluctuates throughout the year as a result of our seasonal business cycle and business expansion, and is generally lowest in the months of January through March of each year and highest during the months of May through October of each year. We historically utilize our revolving credit facility to fund our seasonal working capital requirements. As a result, balances on our revolving credit facility could fluctuate significantly throughout the year. Our working capital decreased to $186.6 million at December 31, 2023, compared to $244.8 million at the end of the prior year primarily due to a decrease in inventory and accounts receivable offset by a decrease in accounts payable.

Our capital expenditures relate primarily to projects relating to our corporate offices, property, merchandising fixtures, molds and equipment associated with our manufacturing and distribution operations and for information technology. Capital expenditures were $4.3 million for 2023 and $7.3 million in 2022. Capital expenditures for 2024 are anticipated to be approximately $5.5 million. 

We lease certain machinery, equipment, and manufacturing facilities under operating leases that generally provide for renewal options. Future minimum lease payments under non-cancelable operating leases are outlined in further detail in Note 11 of our Consolidated Financial Statements.

We believe that our credit facilities coupled with cash generated from operations will provide sufficient liquidity to fund our operations for at least the next twelve months. Our continued liquidity, however, is contingent upon future operating performance, cash flows and our ability to meet financial covenants under our credit facility. For more information regarding our credit facilities please se
e No
te 10.

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Cash Flows and Material Cash Requirements

[[GREPCENT_TABLE]]
[["","","Twelve Months Ended"],["","","December 31,"],["($ in millions)","","2023","","","2022"],["Operating activities","","$","73.6","","","$","19.1"],["Investing activities","","","13.4","","","","(1.2",")"],["Financing activities","","","(88.2",")","","","(18.1",")"],["Net change in cash and cash equivalents","","$","(1.2",")","","$","(0.2",")"]]
[[/GREPCENT_TABLE]]

Operating Activities. Cash provided by operating activities for the year ended December 31, 2023 was $73.6 million compared to $19.1 million for the year ended December 31, 2022. Adjusting for non-cash items, net income provided a cash in-flow of $22.3 million and $35.1 million for the years ended December 31, 2023 and 2022, respectively. The net change in working capital and other assets and liabilities resulted in an increase to cash provided by operating activities of $51.3 million for the year ended December 31, 2023, compared to a decrease of $16.0 million for the year ended December 31, 2022.

During the year ended December 31, 2023, the net change in working capital was primarily impacted by a decrease in inventory and accounts receivable of $60.0 million and $18.2 million, respectively, partially offset by a decrease in accounts payable of $21.2 million. The decrease in inventory during the year ended December 31, 2023 compared to the prior period was due to a concentrated effort to optimize inventory levels in 2023 through increased promotions aimed at selling discontinued inventory, lower production and purchasing. The decrease in accounts receivable was due to collection on our outstanding accounts receivables throughout the year combined with lower sales. The decrease in accounts payable was due to a decrease in our days payable outstanding year-over-year.

Investing Activities. Cash provided by investing activities for the twelve months ended December 31, 2023 was primarily derived from the proceeds from sale of the Servus brand (see Note 4). The principal use of net cash in 2022 was related to investments in molds and equipment associated with our manufacturing operations, investments in information technology and improvements made to our distribution facility. 

Financing Activities. Cash used in financing activities for the twelve months ended December 31, 2023 and 2022 was primarily related to payments on our revolving credit facility and term loan. 

Our prior $7,500,000 share repurchase program expired on March 4, 2022. For additional information regarding this share repurchase program, see Note 14 of our Consolidated Financial Statements. We have not announced a new repurchase program since the expiration of the prior program.

Contractual Obligations and Commercial Commitments

The following table summarizes our contractual obligations at December 31, 2023 resulting from financial contracts and commitments. These amounts are generally consistent from year to year, closely reflect our levels of production, and are not long-term in nature (less than three months). The following table does not include information on our recurring purchases of materials for use in our manufacturing operations.

Contractual Obligations at December 31, 2023:

[[GREPCENT_TABLE]]
[["($ in millions)","","Total","","","Less than 1 Year","","","1-3 Years","","","3-5 Years","","","Over 5 Years"],["Long-term debt (Note 10)","","$","175.0","","","$","2.7","","","$","5.4","","","$","166.9","","","","-"],["Long-Term Taxes payable","","","0.2","","","","-","","","","0.2","","","","-","","","","-"],["Minimum operating lease commitments (Note 11)","","","8.5","","","","2.8","","","","5.6","","","","0.1","","","","-"],["Contract Liabilities (Note 17)","","","0.9","","","","0.9","","","","-","","","","-","","","","-"],["Total contractual obligations","","$","184.6","","","$","6.4","","","$","11.2","","","$","167.0","","","$","-"]]
[[/GREPCENT_TABLE]]

From time to time, we enter into purchase commitments with our suppliers under customary purchase order terms. Any significant losses implicit in these contracts would be recognized in accordance with generally accepted accounting principles. At December 31, 2023, no such losses existed.

Our ongoing business activities continue to be subject to compliance with various laws, rules and regulations as may be issued and enforced by various federal, state and local agencies. With respect to environmental matters, costs are incurred pertaining to regulatory compliance. Such costs have not been, and are not anticipated to become, material.

We are contingently liable with respect to lawsuits, taxes and various other matters that routinely arise in the normal course of business. See Note 21 of our Consolidated Financial Statements for further discussion of legal matters. We do not have off-balance sheet arrangements, financings, or other relationships with unconsolidated entities, also known as "Variable Interest Entities." Additionally, we do not have any related party transactions that materially affect the results of operations, cash flow or financial condition.

OFF-BALANCE SHEET ARRANGEMENTS

We have no off-balance sheet arrangements as of December 31, 2023.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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 judgements 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. Significant accounting policies are summarized in Note 1 to the Company's Consolidated Financial Statements.

Revenue recognition

Revenue principally consists of sales to customers, and, to a lesser extent, license fees. See Note 1 and Note 17 of our Consolidated Financial Statements for additional information regarding revenues.

Allowance for Credit Losses

Management maintains allowances for uncollectible accounts and estimated losses resulting from the inability of our customers to make required payments. We evaluate 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. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Sales returns and allowances

We record a reduction to gross sales based on estimated customer returns and allowances. These reductions are influenced by historical experience based on customer returns and allowances. The actual amount of sales returns and allowances realized may differ from our estimates. If we determine that sales returns or allowances should be either increased or decreased, then the adjustment would be made to net sales in the period in which such a determination is made.

Sales returns and allowances as a percentage of sales for the years ended December 31, 2023 and 2022 were 8.4% and 6.7%, respectively.

Inventories

Management identifies slow moving inventories and estimates appropriate loss provisions related to these inventories. Historically, these loss provisions have not been significant as the vast majority of our inventories are considered saleable and we have been able to liquidate slow moving or obsolete inventories at amounts above cost through our factory outdoor gear stores or through various discounts to customers and e-commerce channels. Should management encounter difficulties liquidating slow moving or obsolete inventories, additional provisions may be necessary. Management regularly reviews the adequacy of our inventory reserves and makes adjustments as required. See Note 6 of our Consolidated Financial Statements for additional information regarding inventories.

Goodwill and Indefinite-Lived Intangibles

Goodwill and intangible assets deemed to have indefinite lives are not amortized but are evaluated for impairment annually or whenever we identify certain triggering events or circumstances that would more likely than not reduce the fair value of the assets below their carrying amount. Events or circumstances that might indicate an interim evaluation is warranted include, among other things, unexpected adverse business conditions, macro and reporting unit specific economic factors, supply costs, and unanticipated competitive activities.

We test goodwill and indefinite-lived intangible assets for impairment annually in the fourth quarter each fiscal year by quantitatively comparing the fair values of the Wholesale and Retail reporting units and indefinite-lived intangibles to their carrying amounts. There was no goodwill allocated to our Contract Manufacturing reporting unit.

For goodwill, we estimated the fair value of each reporting unit by weighing the results of the income and market approaches. These valuation approaches consider a number of factors that include, but are not limited to, prospective financial information, growth rates, discount rates, and comparable multiples from publicly traded companies in our industry and require us to make certain assumptions and estimates regarding industry economic factors and future profitability of our business. When performing the income approach, we utilize the present value of cash flows to estimate fair value. The future cash flows for our reporting units were projected based on our estimates, at that time, of future revenues, operating income, and other factors (such as working capital and capital expenditures). The discount rates used were based on a weighted-average cost of capital determined from relevant market comparisons and take into consideration the risk and nature of the respective reporting unit's cash flows. For the market approach, we use the guideline public company method which relies upon valuation multiples derived from stock prices and enterprise values of publicly traded companies that are comparable to the reporting unit being evaluated.

The fair value of our trade names was determined based on the Income Approach using the Relief from Royalty Method. This method requires us to estimate the future revenues for the related brands, the appropriate royalty rate, and the weighted average cost of capital.

After completing our annual impairment test for each reporting unit and our indefinite-lived intangible assets during the fourth quarter of 2023 and 2022, we concluded there was no impairment in either of these years.

We did not have any reporting units that were at risk of failing the first step of the goodwill impairment test. The estimated fair values of the Wholesale reporting unit and the Retail reporting unit exceeded their carrying amounts at the date of testing by more than 20% for both 2023 and 2022.

Income taxes

Management records a valuation allowance to reduce its deferred tax assets for a portion of state and local income tax net operating losses that it believes may not be realized. We have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance; however, in the event we were to determine that we would not be able to realize all or part of our 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. For additional information see Note 13 of our Consolidated Financial Statements.

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RECENT FINANCIAL ACCOUNTING PRONOUNCEMENTS

Refer to Note 2 to Consolidated Financial Statements for new accounting pronouncements adopted during the current year and the expected impact of accounting pronouncements recently issued but not yet required to be adopted. To the extent the adoption of new accounting standards materially affects financial condition, results of operations, or liquidity, the impacts are discussed in the applicable section of this MD&A and the Notes to Consolidated Financial Statements.

SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This report, including Management’s Discussion and Analysis of Financial Conditions and Results of Operations, contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, which are intended to be covered by the safe harbors created thereby. Those statements include, but may not be limited to, all statements regarding our and management’s intent, belief, expectations, such as statements concerning our future profitability and our operating and growth strategy. Words such as "believe," "anticipate," "expect," "will," "may," "should," "intend," "plan," "estimate," "predict," "potential," "continue," "likely," "would," "could" and similar expressions are intended to identify forward-looking statements. Investors are cautioned that all forward-looking statements involve risk and uncertainties including, without limitations, dependence on sales forecasts, changes in consumer demand, seasonality, impact of weather, competition, reliance on suppliers, risks inherent to international trade, changing retail trends, the loss or disruption of our manufacturing and distribution operations, cyber security breaches or disruption of our digital systems, fluctuations in foreign currency exchange rates, economic changes, as well as other factors set forth under the caption "Item 1A, Risk Factors" in this Annual Report on Form 10-K and other factors detailed from time to time in our filings with the Securities and Exchange Commission. Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate. Therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. We assume no obligation to update any forward-looking statements.