YETI Holdings, Inc. (YETI) FY 2022 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis contains forward-looking statements within the meaning of the federal securities laws, and should be read in conjunction with the disclosures we make concerning risks and other factors that may affect our business and operating results, including those set forth in Part I, Item 1A, “Risk Factors” of this Report. The information contained in this section should also be read in conjunction with our consolidated financial statements and related notes and the information contained elsewhere in this Report. See also “Forward-Looking Statements” immediately prior to Part I, Item 1, “Business” in this Report.

Business Overview

Headquartered in Austin, Texas, YETI is a global designer, retailer, and distributor of innovative outdoor products. From coolers and drinkware to bags and apparel, YETI products are built to meet the unique and varying needs of diverse outdoor pursuits, whether in the remote wilderness, at the beach, or anywhere life takes you. By consistently delivering high-performing, exceptional products, we have built a strong following of brand loyalists throughout the world, ranging from serious outdoor enthusiasts to individuals who simply value products of uncompromising quality and design. We have an unwavering commitment to outdoor and recreation communities, and we are relentless in our pursuit of building superior products for people to confidently enjoy life outdoors and beyond.

We distribute our products through a balanced omni-channel platform, consisting of our wholesale and direct-to-consumer (“DTC”) channels. In our wholesale channel, we sell our products through select national and regional accounts and an assemblage of independent retail partners throughout the United States, Canada, Australia, New Zealand, Europe, and Japan, among others. We carefully evaluate and select retail partners that have an image and approach that are consistent with our premium brand and pricing. Our domestic national and regional specialty retailers include Dick’s Sporting Goods, REI, Academy Sports + Outdoors, Bass Pro Shops, Ace Hardware, and Scheels. We sell our products in our DTC channel to customers on YETI.com, country and region specific YETI websites, and YETI Authorized on the Amazon Marketplace, as well as in our retail stores. Additionally, we offer customized products with licensed marks and original artwork through our corporate sales program and at YETI.com. Our corporate sales program offers customized products to corporate customers for a wide-range of events and activities, and in certain instances may also offer products to re-sell.

Product Introductions and Updates

During the first quarter of 2022, our new product launches included the Hopper® M20 Soft Backpack Cooler, improved Hopper® M30 Soft Cooler, and two new sizes of the Camino™ Carryall as well as new seasonal colorways. During the third quarter of 2022, we expanded our wheeled cooler offerings with the launch of the Roadie Wheeled Cooler in two sizes, and introduced new seasonal colorways and a new Rambler Colster size for our international markets. During the fourth quarter, we further expanded our Drinkware offerings with the Rambler Straw Mugs in two sizes, and also launched the Yonder™ Water Bottles, our first lightweight water bottles made of durable and safe BPA-free material. During the first quarter of 2022, we strategically implemented price increases on certain hard coolers and tumblers.

Proposed Voluntary Recalls

In January 2023, we notified the CPSC of a potential safety concern regarding the magnet-lined closures of our Hopper® M30 Soft Cooler, Hopper® M20 Soft Backpack Cooler, and SideKick Dry gear case and initiated a global stop sale of the affected products. In February 2023, we proposed a voluntary recall of the affected products to the CPSC and other relevant global regulatory authorities. In conjunction with the stop sale, we determined that the affected products inventory held by us, our suppliers, and our wholesale customers is unsalable and notified our wholesale customers to return the affected products. We are working in cooperation with the CPSC and other relevant global regulatory authorities on the corrective action plan and hope to begin implementing the voluntary recalls in the coming weeks. Once our proposed voluntary recall plans are approved, consumers will have the ability to return the affected products for a remedy. We are also working on solutions to address the potential safety concern of the affected products and intend to resume the sale of the redesigned products in the fourth quarter of 2023. However, there are a number of factors that could impact our ability to resume sales at that time and our estimate of the date for sales of the redesigned products to resume may change.

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For the year ended December 31, 2022, we recorded a reduction to net sales for estimated future returns and recall remedies of $38.4 million; recorded costs in cost of goods sold of $58.6 million primarily related to an inventory write-off of $34.1 million for our unsalable inventory on-hand as well as estimated costs of future product replacement remedies and logistics costs; and recorded $31.9 million associated with estimated recall-related costs in selling, general, and administrative expenses. As a result, the total unfavorable impact of the proposed voluntary recalls to operating income was $128.9 million for the year ended December 31, 2022. As of December 31, 2022, our reserve for estimated recall expenses was $94.8 million. The ultimate costs from the approved voluntary recalls may differ materially from our estimates, and may harm our business, financial condition and results of operations. See Part I, Item 1A “Risk Factors - Risks Related to Our Business, Operations and Industry.”

Macroeconomic Conditions

We continue to experience challenges associated with the complex and uncertain macroeconomic environment in which we

operate. Consistent across many industries, we have experienced, and expect to continue to experience, inflationary pressures and supply chain challenges, including port congestion, container and labor shortages, which have resulted in longer transit times, higher distribution, logistics, and product input costs. As a result, we have experienced, and may continue to experience, decreased profitability and delayed product availability for certain products.

Other macroeconomic trends, including rising fuel prices, higher inflation rates, higher interest rates, foreign exchange rate fluctuations, and other related global economic conditions, have led to uncertainty in the economic environment and their impacts remain unknown. While some of these conditions have negatively impacted consumer discretionary spending behavior, we continue to see strong demand for our products.

A continuation or worsening of these macroeconomic trends may continue to adversely impact our business, operations, and financial results. We will continue to monitor and mitigate the effects of the macroeconomic environment on our business.

General

Components of Our Results of Operations

Net Sales. Net sales are comprised of wholesale channel sales to our retail partners and sales through our DTC channel. Net sales in both channels reflect the impact of product returns as well as discounts for certain sales programs or promotions.

We discuss the net sales of our products in our two primary categories: Coolers & Equipment and Drinkware. Our Coolers & Equipment category includes hard coolers, soft coolers, bags, outdoor equipment, and cargo, as well as accessories and replacement parts for these products. Our Drinkware category is primarily composed of our stainless-steel drinkware products and related accessories. In addition, our Other category is primarily comprised of ice substitutes and YETI-branded gear, such as shirts, hats, and other miscellaneous products.

Gross profit. Gross profit reflects net sales less cost of goods sold, which primarily includes the purchase cost of our products from our third-party contract manufacturers, inbound freight and duties, product quality testing and inspection costs, depreciation expense of our molds and equipment, and the cost of customizing Drinkware products. We calculate gross margin as gross profit divided by net sales. Our DTC channel generally generates higher gross margin than our wholesale channel due to differentiated pricing between these channels.

Selling, general, and administrative expenses. Selling, general, and administrative (“SG&A”) expenses consist primarily of marketing costs, employee compensation and benefits costs, costs of our outsourced warehousing and logistics operations, costs of operating on third-party DTC marketplaces, professional fees and services, non-cash stock-based compensation, cost of product shipment to our customers, depreciation and amortization expense, and general corporate infrastructure expenses. Our variable expenses, including outbound freight, online marketplace fees, third-party logistics fees, and credit card processing fees, will vary as they are dependent on our sales volume and our channel mix. Our DTC channel variable SG&A costs are generally higher as a percentage of net sales than our wholesale channel distribution costs.

Fiscal Year. We have a 52- or 53-week fiscal year that ends on the Saturday closest in proximity to December 31, such that each quarterly period will be 13 weeks in length, except during a 53-week year when the fourth quarter will be 14 weeks. Our fiscal years 2022 and 2021 ended on December 31, 2022 and January 1, 2022, respectively, were 52 weeks each, whereas our fiscal year 2020 ended January 2, 2021 included 53 weeks. Unless otherwise stated, references to particular years, quarters, months and periods refer to our fiscal years ended in December and the associated quarters, months, and periods of those fiscal years.

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Results of Operations

The following table sets forth selected statement of operations data, and their corresponding percentage of net sales, for the periods indicated (dollars in thousands):

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(1) Includes $6.4 million of inbound freight expense related to an out-of-period adjustment for year ended December 31, 2022. See Note 1 - Organization and Significant Accounting Policies of the Unaudited Condensed Consolidated Financial Statements for additional information.

Year Ended December 31, 2022 Compared to Year Ended January 1, 2022

Net Sales

Net sales increased $184.2 million, or 13%, to $1,595.2 million in 2022 from $1,411.0 million in 2021. Net sales for fiscal 2022 were negatively impacted by $38.4 million related to the voluntary recalls discussed above. Excluding this impact, the increase in net sales was driven by volume growth in both our DTC and wholesale channels and the benefit of price increases implemented during the first quarter of 2022.

Net sales in our channels were as follows:

•DTC channel net sales increased $133.0 million, or 17%, to $917.7 million in 2022 from $784.7 million in 2021, driven by both Drinkware and Coolers & Equipment categories, partially offset by a $6.2 million unfavorable impact related to the voluntary recalls. Our DTC channel represented 58% and 56% of total net sales in 2022 and 2021, respectively.

•Net sales in our wholesale channel increased $51.3 million, or 8%, to $677.5 million in 2022 from $626.3 million in 2021, primarily driven by Coolers & Equipment, partially offset by a $32.2 million unfavorable impact related to the voluntary recalls. Our wholesale channel represented 42% and 44% of total net sales in 2022 and 2021, respectively.

Net sales in our two primary product categories were as follows:

•Drinkware net sales increased $114.8 million, or 14%, to $947.2 million in 2022 from $832.4 million in 2021, primarily driven by the continued expansion of our Drinkware product offerings, including the introduction of new colorways and sizes, and strong demand for customization.

•Coolers & Equipment net sales increased $60.7 million, or 11%, to $612.5 million in 2022 from $551.9 million in 2021, primarily driven by the strong performance in bags, soft coolers, and hard coolers, partially offset by a $38.4 million unfavorable impact related to the voluntary recalls.

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Gross Profit

Gross profit decreased $52.7 million, or 6%, to $763.4 million in 2022 from $816.1 million in 2021. Gross margin decreased 990 basis points to 47.9% in 2022 from 57.8% in 2021. Gross margin for fiscal 2022 was negatively impacted by $97.0 million related to the voluntary recalls. The decrease in gross margin was primarily driven by:

•higher inbound freight rates, which unfavorably impacted gross margin by 510 basis points;

•the unfavorable impact of the voluntary recalls, which negatively impacted gross margin by 480 basis points;

•higher product costs, which unfavorably impacted gross margin by 120 basis points;

•the unfavorable impact of foreign currency exchange rates, which negatively impacted gross margin by 70 basis points; and

•the non-renewal of the Global System of Preferences (“GSP”), which negatively impacted gross margin by 30 basis points.

These decreases were partially offset by 170 basis points from price increases, 30 basis points from the favorable channel mix shift to DTC channel net sales, and 20 basis points from other impacts.

Selling, General, and Administrative Expenses

SG&A expenses increased by $95.9 million, or 18%, to $637.0 million in 2022 from $541.2 million in 2021. As a percentage of net sales, SG&A expenses increased 150 basis points to 39.9% in 2022 from 38.4% in 2021. The increase in SG&A expenses resulted from:

•an increase in variable expenses of $45.6 million (increasing SG&A as a percent of sales by 140 basis points) comprised of:

–higher distribution costs including higher outbound freight rates, online marketplace fees, third-party logistics fees, and credit card processing fees;

•an increase in non-variable expenses of $18.4 million (decreasing SG&A as a percent of sales by 190 basis points) comprised of:

–an increase in marketing expenses, non-variable distribution costs, information technology expenses and facility costs, partially offset by a decline in employee costs primarily driven by incentive compensation, lower professional fees and other operating expenses; and

•the unfavorable $31.9 million impact related to the voluntary recalls (increasing SG&A as a percent of sales by 200 basis points).

Non-Operating Expenses

Interest expense was $4.5 million in 2022, compared to $3.3 million in 2021. The increase in interest expense was primarily due to rising interest rates partially offset by decreased outstanding long-term debt.

Other expense was $5.7 million in 2022, compared to other income of $3.2 million in 2021. The increase in other expense was due to foreign currency losses on intercompany balances.

Income tax expense was $26.5 million in 2022, compared to $55.8 million in 2021. Our effective tax rate for 2022 was 23% compared to 21% for 2021. The decrease in income tax expense was primarily due to lower earnings before taxes in 2022. The increase in the effective tax rate was primarily due to a lower tax benefit related to stock-based compensation in 2022 compared to 2021.

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Year Ended January 1, 2022 Compared to Year Ended January 2, 2021

Net Sales

Net sales increased $319.3 million, or 29%, to $1,411.0 million in 2021 from $1,091.7 million in 2020. The increase in net sales was driven by our faster growing DTC channel as well as growth in our wholesale channel.

Net sales in our channels were as follows:

•DTC channel net sales increased $203.9 million, or 35%, to $784.7 million in 2021 from $580.9 million in 2020, driven by both Drinkware and Coolers & Equipment categories. Net sales in our DTC channel continue to be favorably impacted by strong demand for outdoor recreation and leisure lifestyle products as well as a favorable shift to online shopping, resulting in an increase in sales volume during the period. As a result, our channel mix continued to shift towards our DTC channel from 53% in 2020 to 56% in 2021.

•Net sales in our wholesale channel increased $115.4 million, or 23%, to $626.3 million in 2021 from $510.9 million in 2020, primarily driven by both Drinkware and Coolers & Equipment. In the second quarter of 2020, wholesale channel net sales were adversely impacted by the temporary store closures due to the COVID-19 pandemic.

Net sales in our two primary product categories were as follows:

•Drinkware net sales increased $203.9 million, or 32%, to $832.4 million in 2021 from $628.6 million in 2020, primarily driven by the continued expansion of our Drinkware product offerings, including the introduction of new colorways and sizes, and strong demand for customization.

•Coolers & Equipment net sales increased $105.3 million, or 24%, to $551.9 million in 2021 from $446.6 million in 2020, primarily driven by the strong performance in bags, outdoor living products, soft coolers, and hard coolers.

Gross Profit

Gross profit increased $187.3 million, or 30%, to $816.1 million in 2021 from $628.8 million in 2020. Gross margin increased 20 basis points to 57.8% in 2021 from 57.6% in 2020. The increase in gross margin was primarily driven by:

•lower inventory reserves, which favorably impacted gross margin by approximately 100 basis points;

•an increase in the mix of higher margin DTC channel net sales, which favorably impacted gross margin by approximately 60 basis points;

•product cost improvements across our product portfolio, net of the impact of product input cost inflation, which favorably impacted gross margin by approximately 40 basis points; and

•fewer promotions in our DTC channel, which favorably impacted gross margin by 10 basis points.

These gains were mostly offset by 90 basis points from higher inbound freight, 80 basis points from the unfavorable impact of the non-renewal of the GSP, which impacted import duties primarily on our hard coolers, as well as other impacts, which unfavorably impacted gross margin by 20 basis points.

Selling, General, and Administrative Expenses

SG&A expenses increased by $126.6 million, or 31%, to $541.2 million in 2021 from $414.6 million in 2020. As a percentage of net sales, SG&A expenses increased 40 basis points to 38.4% in 2021 from 38.0% in 2020. The increase in SG&A expenses resulted from:

•an increase in variable expenses of $41.9 million, resulting in a 20 basis point increase as a percent of net sales, driven by the increased mix of our faster growing and higher gross margin DTC channel, which grew to 56% of net sales for the year comprised of:

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–higher distribution costs including outbound freight, third-party logistics fees, credit card processing fees, and online marketplace fees; and

•an increase in non-variable expenses of $84.7 million, resulting in a 20 basis point increase as a percent of net sales, comprised of:

–an increase in marketing expenses; employee costs, including higher incentive compensation; non-variable distribution costs, including third-party logistics fees; non-cash stock-based compensation expense; facility costs and other operating expenses; information technology expenses; depreciation and amortization expense; and business optimization expenses associated with our new distribution facility in Memphis, Tennessee.

Non-Operating Expenses

Interest expense was $3.3 million in 2021, compared to $9.2 million in 2020. The decrease in interest expense was primarily due to decreased outstanding long-term debt under our Credit Facility.

Other expense was $3.1 million in 2021, compared to other income of $0.1 million in 2020. The increase in other expense was due to foreign currency losses on intercompany balances.

Income tax expense was $55.8 million in 2021, compared to $49.4 million in 2020. Our effective tax rate for 2021 was 21% compared to 24% for 2020. The decrease in the effective tax rate was primarily due to a higher tax benefit related to stock-based compensation in 2021 compared to 2020.

Liquidity and Capital Resources

General

Our cash requirements have principally been for working capital purposes, long-term debt repayments, and capital expenditures. We fund our working capital, primarily inventory and accounts receivable, and capital investments from cash flows from operating activities, cash on hand, and borrowings available under our Revolving Credit Facility (as defined below). We may also use cash to repurchase shares of our common stock. We believe that our current operating performance, operating plan, our strong cash position, and borrowings available under our Revolving Credit Facility will be sufficient to satisfy our foreseeable liquidity needs and capital expenditure requirements, including for at least the next twelve months.

Current Liquidity

As of December 31, 2022, we had a cash balance of $234.7 million, $75.1 million of working capital (excluding cash), and $150.0 million of borrowings available under the Revolving Credit Facility (as defined below).

Credit Facility

We are party to a senior secured credit agreement (the “Credit Facility”) that provides for a $150.0 million Revolving Credit Facility maturing on December 17, 2024 (the “Revolving Credit Facility”) and a $300.0 million Term Loan A maturing on December 17, 2024 (the “Term Loan A”). At December 31, 2022, we had $90.0 million principal amount of indebtedness outstanding under the Term Loan A and no outstanding borrowings under the Revolving Credit Facility. The weighted average interest rate for borrowings under Term Loan A was 3.49% during the year ended December 31, 2022.

The Credit Facility requires us to comply with certain covenants, including financial covenants regarding our total net leverage ratio and interest coverage ratio. Fluctuations in these ratios may increase our interest expense. Failure to comply with these covenants and certain other provisions of the Credit Facility, or the occurrence of a change of control, could result in an event of default and an acceleration of our obligations under the Credit Facility or other indebtedness that we may incur in the future. At December 31, 2022, we were in compliance with all covenants and expect to remain in compliance with all covenants under the Credit Facility.

Share Repurchase Plan

On February 27, 2022, the Board of Directors authorized a common stock repurchase program of up to $100.0 million. During the first quarter of 2022, we repurchased 1,676,551 shares for an aggregate purchase price of $100.0 million, including fees and commissions, at an average repurchase price of $59.66 per share. Following the repurchases, no shares remained available for future repurchases under the share repurchase program. See Note 10-Stockholders’ Equity of Notes to Consolidated Financial Statements for additional information about the share repurchase program.

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Material Cash Requirements

For 2023, we expect capital expenditures for property and equipment to be approximately $60 million, primarily to support investments in technology, expansion of our customization capacity, retail stores investments, and new product innovation and launches.

The following table summarizes current and long-term material cash requirements for contractual and other obligations as of December 31, 2022 (in thousands):

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(1)We have entered into commitments for service and maintenance agreements related to our management information systems, distribution contracts, advertising, sponsorships, and licensing agreements.

The table of our material cash requirements above excludes unrecognized tax benefits as we are unable to reasonably predict the timing of settlement of liabilities, if any, related to unrecognized tax benefits. As of December 31, 2022, we had unrecognized tax benefits of $14.6 million.

As of December 31, 2022, our reserve for estimated recall expenses, including the expected cost of returns, was $94.8 million. The ultimate costs from the approved voluntary recalls could differ materially from this estimate, and as such, changes in the estimate may have a material impact on our financial condition, results of operations, and cash flows.

Cash Flows from Operating, Investing and Financing Activities

The following table summarizes our cash flows from operating, investing and financing activities for the periods indicated (in thousands):

Operating Activities

Cash flows related to operating activities are dependent on net income, non-cash adjustments to net income, and changes in working capital.

The decrease in cash provided by operating activities in 2022 is primarily due to an increase in cash used for working capital, partially offset by net income, adjusted for non-cash items, including the impact of our voluntary recalls, for the periods compared. The increase in cash used for working capital was primarily due to an increase in inventory and a decrease in accounts payable, partially offset by a decrease in accounts receivable.

The decrease in cash provided by operating activities in 2021 compared to cash provided by operating activities in 2020 is primarily due to an increase in cash used for working capital, partially offset by an increase in net income, adjusted for non-cash items, for the periods compared. The increase in cash used for working capital was primarily due to an increase in inventory, partially offset by an increase in accounts payable.

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Investing Activities

The decrease in cash used in investing activities in 2022 compared to 2021 primarily related to lower purchases for technology upgrades and enhancements, as well as production molds, tooling and equipment, and facilities.

The increase in cash used in investing activities in 2021 compared to 2020 primarily related to increased purchases for technology upgrades and enhancements, including the phased upgrade of our SAP enterprise resource planning (“ERP”) system and investment in data analytics, as well as production molds, tooling and equipment, and facilities.

Financing Activities

The increase in cash used in financing activities in 2022 compared to 2021 was primarily driven by repurchases of common stock.

The decrease in cash used in financing activities in 2021 compared to 2020 was primarily driven by lower repayments of long-term debt in 2021.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. In preparing the consolidated financial statements, we make estimates and judgments that affect the reported amounts of assets, liabilities, sales, expenses, and related disclosure of contingent assets and liabilities. We re-evaluate our estimates on an on-going basis. Our estimates are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Because of the uncertainty inherent in these matters, actual results may differ from these estimates and could differ based upon other assumptions or conditions.

See Note 1 of the Notes to Consolidated Financial Statements for our significant accounting policies. The following describes significant judgments and estimates used in the application of these policies. Within the context of these critical accounting policies, we are not currently aware of any reasonably likely events or circumstances that would result in materially different amounts being reported.

Revenue Recognition

Revenue transactions associated with the sale of YETI branded coolers, equipment, drinkware, apparel and accessories comprise a single performance obligation, which consists of the sale of products to customers either through our wholesale or DTC channels. Revenue is recognized when performance obligations are satisfied through the transfer of control of promised goods to the customers, based on the terms of sale. The transfer of control typically occurs at a point in time based on consideration of when the customer has an obligation to pay for the goods, and physical possession of, legal title to, and the risks and rewards of ownership of the goods has been transferred, and the customer has accepted the goods. Revenue from wholesale transactions is generally recognized at the time products are shipped based on contractual terms with the customer. Revenue from our DTC channel is generally recognized at the point of sale in our retail stores and at the time products are shipped for e-commerce transactions and corporate sales based on contractual terms with the customer.

Revenue is recognized net of estimates of variable consideration, including product returns, customer discounts and allowances, sales incentive programs, and miscellaneous claims from customers. We determine these estimates based on contract terms, evaluations of historical experience, anticipated trends, and other factors. The actual amount of customer returns and customer allowances, which is inherently uncertain, may differ from our estimates.

The duration of contractual arrangements with our customers is typically less than 1 year. Payment terms with wholesale customers vary depending on creditworthiness and other considerations, with the most common being net 30 days. Payment is due at the time of sale for retail store transactions and at the time of shipment for e-commerce transactions.

Certain products that we sell include a limited warranty which does not meet the definition of a performance obligation within the context of the contract. Product warranty costs are estimated based on historical and anticipated trends and are recorded as cost of goods sold at the time revenue is recognized.

We elected to account for shipping and handling as fulfillment activities, and not as separate performance obligations. Shipping and handling fees billed to customers are included in net sales. All shipping and handling activity costs are recognized as selling, general and administrative expenses at the time the related revenue is recognized. Sales taxes collected from customers and remitted directly to government authorities are excluded from net sales and cost of goods sold.

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Our terms of sale provide limited return rights. We may accept, and have at times accepted, returns outside our terms of sale at our sole discretion. We may also, at our sole discretion, provide our retail partners with sales discounts and allowances. We record estimated sales returns, discounts, and miscellaneous customer claims as reductions to net sales at the time revenues are recorded. We base our estimates upon historical experience and trends, and upon approval of specific returns or discounts. Actual returns and discounts in any future period are inherently uncertain and thus may differ from our estimates. If actual or expected future returns and discounts were significantly greater or lower than the reserves we had established, we would record a reduction or increase to net sales in the period in which we made such determination. A 10% change in our estimated reserve for sales returns, discounts, and miscellaneous claims for 2022 would have impacted net sales by $1.0 million.

Product Recall Reserves

As described in Note 11 of the Notes to Consolidated Financial Statements, in January 2023, we notified the CPSC of a potential safety concern regarding the magnet-lined closures of our Hopper® M30 Soft Cooler, Hopper® M20 Soft Backpack Cooler, and SideKick Dry gear case (the “affected products”) and initiated a global stop sale of the affected products. In February 2023, we proposed a voluntary recall of the affected products to the CPSC, and other relevant global regulatory authorities, which we refer to as the “voluntary recalls” herein unless otherwise indicated. In conjunction with the stop sale, we determined that the affected products inventory held by us, our suppliers and our wholesale customers is unsalable, and notified our wholesale customers to return the affected products. We are working in cooperation with the CPSC and other relevant global regulatory authorities on the corrective action plan and hope to begin implementing the voluntary recalls in the coming weeks. Once our proposed voluntary recall plans are approved, consumers will have the ability to return the affected products for a remedy.

We establish reserves for the estimated costs of a product recall when circumstances giving rise to the recall become known and when such costs are probable and estimable. As a result of the voluntary recalls, we established a reserve for expected future returns and the estimated cost of recall remedies for consumers with affected products. Estimating the cost of recall remedies required significant judgment and is primarily based on i) expected consumer participation rates; and ii) the estimated costs of the consumer’s elected remedy in the proposed voluntary recall, including estimated cost of offered product replacements, logistics costs and other recall-related costs. We will reevaluate these assumptions each period, and the related reserves may be adjusted when factors indicate that the reserve is either not sufficient to cover or exceeds the estimated product recall expenses. The ultimate impact from the approved voluntary recalls could differ materially from these estimates. The reserve for the estimated product recall expenses of $94.8 million is included within accrued expenses and other current liabilities on our consolidated balance sheet as of December 31, 2022. In addition, we recorded an inventory reserve or write-off of $34.1 million for our unsalable inventory on-hand as of December 31, 2022.

Inventory

Inventories are comprised primarily of finished goods and are carried at the lower of cost (weighted-average cost method) or market (net realizable value). We make ongoing estimates relating to the net realizable value of inventories based upon our assumptions about future demand and market conditions. If the estimated net realizable value is less than cost, we reflect the lower value of that inventory. This methodology recognizes inventory exposures at the time such losses are identified rather than at the time the inventory is actually sold. Due to customer demand and inventory constraints, we have not historically taken material adjustments to the carrying value of our inventory.

Our inventory valuation reflects adjustments for anticipated inventory losses that have occurred since the last physical inventory. We estimate inventory shrinkage based on historical trends from physical inventory counts and cycle counts. We perform physical inventory counts and cycle counts throughout the year and adjust the shrink provision accordingly. Historically, physical inventory shrinkage has not been significant.

Valuation of Goodwill and Indefinite-Lived Intangible Assets

Goodwill and intangible assets are recorded at cost, or at their estimated fair values at the date of acquisition. We review goodwill and indefinite-lived intangible assets for impairment annually or whenever events or changes in circumstances indicate the carrying amount may be impaired. In conducting our annual impairment test, we first review qualitative factors to determine whether it is more likely than not that the fair value of the asset, or reporting units, is less than its carrying amount. If factors indicate that the fair value is less than its carrying amount, we perform a quantitative assessment, analyzing the expected present value of future cash flows to quantify the amount of impairment, if any. Based on our qualitative assessment performed during the fourth quarter of 2022, we determined that it is not more likely than not that the fair value of each reporting unit is lower than its carrying value; therefore, the quantitative impairment test was not required. We did not record any goodwill or indefinite-lived intangible assets impairment charges during the years ended December 31, 2022, January 1, 2022, and January 2, 2021.

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Valuation of Long-Lived Assets

We assess the recoverability of our long-lived assets, which include property and equipment, operating lease right-of-use-assets, and definite-lived intangible assets, for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. An impairment loss on our long-lived assets exists when the estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. If the carrying amount exceeds the sum of the undiscounted cash flows, an impairment charge is recognized based on the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or estimated fair value less costs to sell.

Income Taxes

We are subject to taxation in the United States, as well as various state and foreign jurisdictions. The determination of our provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. On an interim basis, we estimate our effective tax rate for the full fiscal year. This estimated annual effective tax rate is then applied to the year-to-date income before income taxes, excluding infrequently occurring or unusual items, to determine the year-to-date income tax expense. The income tax effects of infrequent or unusual items are recognized in the interim period in which they occur. As the fiscal year progresses, we continually refine our estimate based upon actual events and earnings by jurisdiction during the year. This continual estimation process periodically results in a change to our expected effective tax rate for the fiscal year. When this occurs, we adjust the income tax provision during the quarter in which the change in estimate occurs.

Tax filing positions are evaluated, and we recognize the largest amount of tax benefit that is more likely than not to be sustained upon examination by the taxing authorities based on the technical merits of the tax position. On a quarterly basis, we evaluate the probability that a tax position will be effectively sustained and the appropriateness of the amount recognized for uncertain tax positions based on factors including changes in facts or circumstances, changes in tax law, and audit activity. Changes in our assessment may result in the recognition of a tax benefit or an additional charge to the tax provision in the period our assessment changes. We recognize interest and penalties related to unrecognized tax benefits in the provision for income taxes in the consolidated statements of operations.

Recent Accounting Pronouncements

For a description of recent accounting pronouncements, see “Recently Adopted Accounting Pronouncements” and “Recent Accounting Guidance Not Yet Adopted” in Note 1 of the Notes to Consolidated Financial Statements included herein.