|• FORM 10-Q • EX-31.1 • EX-31.2 • EX-32 • XBRL INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE • XBRL TAXONOMY EXTENSION DEFINITION LINKBASE • XBRL TAXONOMY EXTENSION LABEL LINKBASE • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE|
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the quarterly period ended June 30, 2012
For the transition period from to
Commission file number: 0-18914
Dorman Products, Inc.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
As of July 27, 2012, the registrant had 36,401,562 shares of common stock, par value $0.01 per share, outstanding.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
June 30, 2012
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See accompanying Notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying Notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
See accompanying Notes to Consolidated Financial Statements
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CONSOLIDATED BALANCE SHEETS
See accompanying Notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying Notes to Consolidated Financial Statements
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE TWENTY-SIX WEEKS ENDED JUNE 30, 2012 AND JUNE 25, 2011
As used herein, unless the context otherwise requires, Dorman, the Company, we, us, or our refers to Dorman Products, Inc. and its subsidiaries. Our ticker symbol on NASDAQ is DORM.
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the U.S. for interim financial information and in accordance with the rules and regulations of the U.S. Securities and Exchange Commission (SEC). However, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the twenty-six weeks ended June 30, 2012 are not necessarily indicative of the results that may be expected for the fiscal year ending December 29, 2012. We may experience significant fluctuations from quarter to quarter in our results of operations due to the timing of orders placed by our customers. Generally, the second and third quarters have the highest level of customer orders. The introduction of new products and product lines to customers may cause significant fluctuations from quarter to quarter. These financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
On May 15, 2012, our Board of Directors declared a two-for-one split of our common stock, payable in the form of a stock dividend of one share for each share held. The Board set June 1, 2012 as the record date for the determination of the shareholders entitled to receive the additional shares. The shares were distributed to the shareholders of record on June 15, 2012. All amounts related to shares, share prices and earnings per share have been retroactively restated. In addition, shareholders equity has been retroactively restated by reclassifying the par value of the additional shares issued to common stock from additional paid in capital.
On September 21, 2011, we announced our plan to exit the international portion of our ScanTech business due to continued operating losses and to focus on growing our North American business. ScanTech was headquartered outside Stockholm, Sweden and distributed a line of Volvo and Saab replacement parts throughout the world. As of June 30, 2012, the business has been disposed of. During the thirteen weeks ended June 30, 2012, we reclassified approximately $3.0 million of previously recorded currency translation adjustments from accumulated other comprehensive income to net income as a result of our substantial liquidation of our investment and recorded a deferred tax asset of $0.7 million related to foreign tax credits we expect to utilize in the future. Additionally, included in ScanTechs costs of goods sold are $0.8 million of reductions of previously recognized inventory reserves resulting from the sale of inventory during the twenty-six weeks ended June 30, 2012.
The following table summarizes ScanTechs net sales and income before taxes which have been presented as a discontinued operation in the Consolidated Statements of Operations for the thirteen and twenty- six weeks ended June 30, 2012 and June 25, 2011:
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We have entered into several customer sponsored programs administered by unrelated financial institutions that permit us to sell certain accounts receivable at discounted rates to the financial institutions. We do not service the receivables after the sales transactions. Transactions under these agreements were accounted for as sales of accounts receivable and were removed from our consolidated balance sheet at the time of the sales transactions. Pursuant to these arrangements, we sold accounts receivable in the aggregate amount of $154.8 million and $95.1 million during the twenty-six weeks ended June 30, 2012 and June 25, 2011, respectively. If receivables had not been sold, $161.1 million and $137.0 million of additional receivables would have been outstanding at June 30, 2012 and December 31, 2011, respectively, based on standard payment terms. Selling, general and administrative expenses for the twenty-six weeks ended June 30, 2012 and June 25, 2011 included $2.0 million and $1.8 million, respectively, in financing costs associated with these accounts receivable sales programs.
Inventories include the cost of material, freight, direct labor and overhead utilized in the processing of our products, and are stated at the lower of average cost or market. Inventories were as follows:
Our 2008 Stock Option and Stock Incentive Plan was approved by our shareholders on May 20, 2009 (the Plan). Under the terms of the Plan, our Board of Directors may grant up to 2,000,000 shares of common stock in the form of incentive stock options, non-qualified stock options and shares of restricted stock or combinations thereof to officers, directors, employees, consultants and advisors. Grants under the Plan must be made within ten years of the date the Plan was approved and stock options are exercisable upon the terms set forth in the grant agreement approved by the Board of Directors, but in no event more than ten years from the date of grant. At June 30, 2012, 1,676,200 shares were available for grant under the Plan.
We expense the grant-date fair value of stock options. Compensation cost is recognized on a straight-line basis over the vesting period during which employees perform related services. The compensation cost charged against income for stock options for the twenty-six weeks ended June 30, 2012 and June 25, 2011 was $98,000 and $125,000, respectively, before taxes. The compensation cost recognized is classified as selling, general and administrative expense in our Consolidated Statements of Operations. No compensation cost was capitalized during 2012 or 2011. We have included a forfeiture assumption of 5.4% for fiscal 2012 and fiscal 2011 in the calculation of compensation cost. Cash flows resulting from tax deductions in excess of compensation cost recognized in the financial statements are classified as a cash flow from financing activities.
We use the Black-Scholes option valuation model to estimate the fair value of options granted. Expected volatility and expected dividend yield are based on the actual historical experience of our common stock. The expected life represents the period of time that options granted are expected to be outstanding and is calculated using historical option exercise data. The risk-free rate is based on the U.S. Treasury security with terms equal to the expected time of exercise as of the grant date. During the twenty-six weeks ended June 30, 2012, we granted 20,000 stock options. There were no stock options granted in the twenty-six weeks ended June 25, 2011.
The following table summarizes our stock option activity for the twenty-six weeks ended June 30, 2012:
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The total intrinsic value of stock options exercised in the twenty-six weeks ended June 30, 2012 was $6.0 million. Cash received from option exercises under the Plan in the twenty-six weeks ended June 30, 2012 was $1.3 million. The excess tax benefit generated from options which were exercised in the twenty-six weeks ended June 30, 2012 was $1.5 million and was credited to additional paid in capital.
As of June 30, 2012, there was approximately $0.6 million of unrecognized compensation cost related to non-vested stock options, which is expected to be recognized over a weighted-average period of approximately 3.4 years.
We grant restricted stock to certain employees and members of our Board of Directors. The value of restricted stock issued is based on the fair value of our common stock on the grant date. Vesting of restricted stock is conditional based on continued employment or service for a specified period. Compensation cost related to restricted stock is recognized on a straight-line basis over the vesting period. We retain the restricted stock until the vesting provisions have been met. No dividends are paid on restricted stock. Compensation cost related to restricted stock was $396,000 and $135,000 for the twenty-six weeks ended June 30, 2012 and June 25, 2011, respectively. During the twenty-six weeks ended June 30, 2012, we granted 10,000 shares of restricted stock. We did not grant any restricted stock during the twenty-six weeks ended June 25, 2011.
The following table summarizes our restricted stock activity for the twenty-six weeks ended June 30, 2012:
As of June 30, 2012, there was approximately $2.9 million of unrecognized compensation cost related to nonvested restricted stock, which is expected to be recognized over a weighted-average period of approximately 3.7 years.
Basic earnings per share was calculated by dividing our net income by the weighted average number of common shares outstanding during the period, excluding nonvested restricted stock which is considered to be contingently issuable. To calculate diluted earnings per share, common share equivalents are added to the weighted average number of common shares outstanding. Common share equivalents are computed based on the number of outstanding stock options and unvested restricted stock as calculated using the treasury stock method. However, in periods when the exercise price of our stock options, by grant, is greater than our average stock price during the period, those common share equivalents are considered anti-dilutive and are excluded from the calculation of diluted earnings per share. Options to purchase 50,000 and 30,000 shares of common stock were outstanding at June 30, 2012 and June 25, 2011, respectively, but were excluded from the calculation of dilutive earnings per share as their effect would have been anti-dilutive.
The following table sets forth the computation of basic earnings per share and diluted earnings per share:
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We periodically repurchase, at the then current market price, and cancel common stock issued to the Dorman Products, Inc. 401(k) Retirement Plan and Trust (the 401(k) Plan). Shares are generally purchased from the 401(k) Plan when participants sell units as permitted by the plan or elect to leave the plan upon retirement, termination or other reasons. For the twenty-six weeks ended June 30, 2012, we repurchased and cancelled 31,208 shares of common stock at an average price of $24.11 per share. During the fifty-three weeks ended December 31, 2011, we repurchased and cancelled 90,268 shares of common stock at an average price of $17.59 per share.
We have entered into a non-cancelable operating lease for our primary operating facility with a partnership in which Steven L. Berman, our Chief Executive Officer, and his family members, are partners. Based upon the terms of the lease, payments in fiscal 2012 will be $1.5 million. Total rental payments to the partnership under the lease arrangement were $1.4 million in fiscal 2011. The lease with the partnership expires December 28, 2012. We are currently pursuing a new lease agreement.
At June 30, 2012, we had $1.8 million of net unrecognized tax benefits, $1.2 million of which would affect our effective tax rate if recognized. We recognize interest and penalties related to uncertain tax positions in income tax expense. As of June 30, 2012, we had approximately $0.2 million of accrued interest related to uncertain tax positions.
The last United States federal return examined by the Internal Revenue Service was 2005, and all years up through and including that year are closed by examination. We are currently under examination for the tax years 2007-2009 by one state tax authority to which we are subject to tax. The tax years 2008-2011 remain open to examination by the remaining major taxing jurisdictions in the United States to which we are subject. The tax years 2007-2011 remain open to examination in Sweden for our Swedish subsidiary.
The carrying value of financial instruments such as cash, accounts receivable, accounts payable, and other current assets and liabilities approximate their fair value based on the short-term nature of these instruments.
In June 2011, the Financial Accounting Standards Board (FASB) issued an update to its authoritative guidance which allows only two options for presenting the components of net income and other comprehensive income: (1) in a single continuous financial statement or (2) in two separate but consecutive financial statements. Also, items that are reclassified from other comprehensive income to net income must be presented on the face of the financial statements. The guidance is effective in two stages: the requirement to present a single continuous statement or two separate but consecutive statements was effective for us beginning January 1, 2012; however the requirement to present the reclassification adjustments from other comprehensive income to net income on the face of the financial statements has been deferred by the FASB indefinitely, pending further deliberations on this requirement. We adopted the first stage of this update on January 1, 2012. The adoption of this update affects presentation only and therefore, did not impact our results of operations, financial condition or cash flows.
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DORMAN PRODUCTS, INC. AND SUBSIDIARIES
Cautionary Statement Regarding Forward Looking Statements
Certain statements in this document constitute forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. While forward-looking statements sometimes are presented with numerical specificity, they are based on various assumptions made by management regarding future circumstances over many of which the Company has little or no control. Forward-looking statements may be identified by words including anticipate, believe, estimate, expect, and similar expressions. The Company cautions readers that forward-looking statements, including, without limitation, those relating to future business prospects, revenues, working capital, liquidity, and income, are subject to certain risks and uncertainties that would cause actual results to differ materially from those indicated in the forward-looking statements. Factors that could cause actual results to differ from forward-looking statements include but are not limited to: (i) competition in the automotive aftermarket; (ii) unfavorable economic conditions; (iii) the loss or decrease in sales among one of our top customers; (iv) customer consolidation in the automotive aftermarket leading to less favorable customer contract terms; (v) the cancellation or rescheduling of orders; (vi) foreign currency fluctuations and our dependence on foreign suppliers; (vi) extended credit to customers who may be unable to pay; (vii) the loss of a key vendor; (viii) limited customer shelf space; (ix) reliance on new product development; (x) patent filings made by original equipment manufacturers continuing to increase; (xi) quality problems with product after their production and sale to customers; (xii) loss of third party transportation providers on whom we depend; (xiii) improperly executed, or unrealized cost savings from, our on-going information technology initiatives; (xiv) unfavorable results of legal proceedings; (xv) dependence on senior management and control by officers, directors, and family members; (xvi) exposure to certain regulatory and financial risks related to climate change; and (xvii) healthcare reform legislation. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected. For additional information concerning factors that could cause actual results to differ materially from the information contained in this report, reference is made to the information in Part I, Item 1A Risk Factors in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2011. You should not place undue reliance on forward-looking statements. Such statements speak only as to the date on which they are made, and we undertake no obligation to update publicly or revise any forward-looking statement, regardless of future developments or availability of new information.
The following discussion and analysis, as well as other sections in this Quarterly Report on Form 10-Q, should be read in conjunction with the unaudited condensed consolidated financial statements and footnotes thereto of Dorman Products, Inc. and its subsidiaries included in Item 1 Consolidated Financial Statements of this Quarterly Report on Form 10-Q and with Managements Discussion and Analysis of Financial Condition and Results of Operations and the audited financial statements and footnotes thereto included in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
We are a supplier of automotive replacement parts, fasteners and service line products primarily for the automotive aftermarket. We market approximately 128,000 different automotive replacement parts (including brake parts), fasteners and service line products which are manufactured to our specifications. Approximately 26% of our parts and 63% of our net sales consist of parts and fasteners that were original equipment dealer exclusive items at the time of their introduction. Original equipment dealer exclusive parts are those which were traditionally available to consumers only from original equipment manufacturers or salvage yards and include, among other parts, intake manifolds, exhaust manifolds, oil cooler lines, window regulators, radiator fan assemblies, power steering pulleys and harmonic balancers. Fasteners include such items as oil drain plugs and wheel lug nuts. Approximately 79% of our products are sold under our brand names and the remainder are sold for resale under customers private labels, other brands or in bulk. Our products are sold primarily in the United States and Canada through automotive aftermarket retailers (such as AutoZone, Advance Auto Parts and OReilly Automotive), national, regional and local warehouse distributors (such as Carquest Auto Parts and NAPA Auto Parts), and specialty markets and salvage yards. We distribute automotive replacement parts internationally, with sales into Europe, Mexico, the Middle East, Asia and Canada.
We generate over 90% of our revenues from customers in the North American automotive aftermarket. The aftermarket has benefited from some of the factors affecting the general economy including the recent
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recession, tighter credit and higher unemployment. These conditions as well as others have resulted in consumers owning their vehicles longer as the average age of a vehicle on the road has increased to 10.8 years. This trend, if it continues, will increase the number of automotive parts that need replacing. Another important statistic impacting our market is total miles driven. Total U.S. miles driven increased slightly in 2009 and 2010, but declined in 2011. We believe that the combination of these factors accounted for a portion of our sales growth.
While the overall automotive aftermarket in which we compete has benefited from the conditions mentioned above, our customer base has been consolidating over the past several years. As a result, our customers regularly seek more favorable pricing, product returns and extended payment terms when negotiating with us. While we attempt to avoid or minimize such concessions, in some cases pricing concessions have been made, customer payment terms have been extended and product returns have exceeded historical levels. The product returns and more favorable pricing primarily affect our profit levels while payment term extensions generally reduce operating cash flow and require additional capital to finance the business. We expect our customers to continue to exert pressure on these and other factors for the foreseeable future. We also expect our customers to continue to exert pressure on our margins. We have increased our focus on efficiency improvements, product cost reduction, and other initiatives to offset the impact of further margin and cash flow pressures.
In addition, we are relying on new product development as a way to offset some of these customer demands and as our primary vehicle for growth. As such, new product development is a critical success factor for us. We have invested heavily in resources necessary for us to increase our new product development efforts and to strengthen our relationships with our customers. These investments are primarily in the form of increased product development resources and awareness programs and customer service improvements. We believe this has enabled us to provide an expanding array of new product offerings and grow our revenues.
We may experience significant fluctuations from quarter to quarter in our results of operations due to the timing of orders placed by our customers. Generally, the second and third quarters have the highest level of customer orders, but the introduction of new products and product lines to customers may cause significant fluctuations from quarter to quarter.
We operate on a fifty-two or fifty-three week fiscal year period ending on the last Saturday of the calendar year. Our 2012 fiscal year will be a fifty-two week period that will end on December 29, 2012.
Results of Operations
The following table sets forth, for the periods indicated, the percentage of net sales represented by certain items in our Consolidated Statements of Operations:
Thirteen Weeks Ended June 30, 2012 Compared to Thirteen Weeks Ended June 25, 2011
Net sales increased 14% to $144.2 million for the thirteen weeks ended June 30, 2012 from $127.0 million for the thirteen weeks ended June 25, 2011. Our revenue growth was primarily driven by strong overall demand for our products and higher revenues from recently-introduced products.
Cost of goods sold, as a percentage of net sales, decreased to 63.1% for the thirteen weeks ended June 30, 2012 from 64.1% for the thirteen weeks ended June 25, 2011. The decrease was due primarily to lower transportation costs and a favorable change in sales mix.
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Selling, general and administrative expenses were approximately $27.4 million for the thirteen weeks ended June 30, 2012 compared to $25.1 million for the thirteen weeks ended June 25, 2011. The spending increase was the result of higher variable costs related to our sales increase, additional product development spending and inflationary increases.
Interest expense, net, approximated prior year levels for the thirteen weeks ended June 30, 2012.
Our effective tax rate was 37.3% for both the thirteen weeks ended June 30, 2012 and ended June 25, 2011.
Twenty-six Weeks Ended June 30, 2012 Compared to Twenty-six Weeks Ended June 25, 2011
Net sales increased 13% to $279.0 million for the twenty-six weeks ended June 30, 2012 from $247.2 million for the twenty-six weeks ended June 25, 2011. Our revenue growth was primarily driven by strong overall demand for our products and higher revenues from recently-introduced products.
Cost of goods sold, as a percentage of net sales, decreased to 62.9% for the twenty-six weeks ended June 30, 2012 from 63.4% for the twenty-six weeks ended June 25, 2011. The decrease was due primarily to lower transportation costs and a favorable change in sales mix.
Selling, general and administrative expenses were approximately $53.5 million for the twenty-six weeks ended June 30, 2012 compared to $49.9 million for the twenty-six weeks ended June 25, 2011. The spending increase was the result of higher variable costs related to our sales increase, additional product development spending and inflationary increases.
Interest expense, net, approximated prior year levels for the twenty-six weeks ended June 30, 2012.
Our effective tax rate was 37.3% in the twenty-six weeks ended June 30, 2012 compared to 35.6% in the same period last year. The effective tax rate in fiscal 2011 was favorably impacted by the 2011 receipt of tax exempt life insurance proceeds to fund an officers death benefit.
Liquidity and Capital Resources
Historically, we have financed our growth through a combination of cash flow from operations, accounts receivable sales programs provided by certain customers and through the issuance of senior indebtedness through our bank credit facility and senior note agreements. At June 30, 2012, working capital was $293.7 million, while shareholders equity was $351.2 million. Cash and cash equivalents as of June 30, 2012 was $65.2 million.
Over the past several years we have continued to extend payment terms to certain customers as a result of customer requests and market demands. These extended terms have resulted in increased accounts receivable levels and significant uses of cash flow. We participate in accounts receivable sales programs with several customers which allow us to sell our accounts receivable to financial institutions to offset the negative cash flow impact of these payment terms extensions. Pursuant to these arrangements, we sold accounts receivable in the aggregate amount of $154.8 million and $95.1 million during the twenty-six weeks ended June 30, 2012 and June 25, 2011, respectively. If receivables had not been sold, $161.1 million and $137.0 million of additional receivables would have been outstanding at June 30, 2012 and December 31, 2011, respectively, based on standard payment terms. We expect continued pressure to extend our payment terms for the foreseeable future. Further extensions of customer payment terms will result in additional uses of cash flow or increased costs associated with the sale of accounts receivable.
We have a $30.0 million revolving credit facility which expires in June 2013. Borrowings under the facility are on an unsecured basis with interest at rates ranging from LIBOR plus 100 basis points to LIBOR plus 250 basis points based upon the achievement of certain benchmarks related to the ratio of funded debt to EBITDA, as defined by our credit agreement. The interest rate at June 30, 2012 was LIBOR plus 100 basis points (1.25%). There were no borrowings under the facility as of June 30, 2012. As of June 30, 2012, we had three outstanding letters of credit for approximately $0.9 million in the aggregate which were issued to secure ordinary course of business transactions. Net of these letters of credit, we had approximately $29.1 million available under the facility at June 30, 2012. The credit agreement also contains covenants, the most restrictive of which pertain to net worth and the ratio of debt to EBITDA.
Our business activities do not include the use of unconsolidated special purpose entities, and there are no significant business transactions that have not been reflected in the accompanying financial statements.
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Cash generated from our operating activities was $23.4 million in the twenty-six weeks ended June 30, 2012. Net income and accounts payable increases of $14.9 million were the primary sources of operating cash flow. Accounts payable increased due to the timing of payments to suppliers and higher inventory levels. The primary uses of cash were inventory, which increased $21.4 million in conjunction with our sales growth and efforts to improve customer order fill rates, and accrued compensation and other current liabilities which decreased $4.4 million due to annual payments which were accrued at December 31, 2011 and paid during our first fiscal quarter.
Investing activities used $9.5 million of cash in the twenty-six weeks ended June 30, 2012 primarily as a result of additions to property, plant and equipment. Capital spending in the twenty-six weeks ended June 30, 2012 consisted of upgrades to information systems, tooling associated with new products, and scheduled equipment replacements. In the third quarter of 2010, we began a project to replace our enterprise resource planning system. This project is expected to cost approximately $17.7 million in software, installation services and capitalized internal costs in fiscal 2010 through fiscal 2013. Through June 30, 2012, we have spent $10.6 million on the project, of which $4.0 million was spent in 2012.
Financing activities provided $1.1 million of cash in the twenty-six weeks ended June 30, 2012, primarily related to proceeds received from the exercise of stock options which were partially offset by stock repurchases from the 401(k) Plan.
On September 21, 2011, we announced our plan to exit the international portion of our ScanTech business which was headquartered outside Stockholm, Sweden. As of June 30, 2012, the business had been disposed of and is presented as a discontinued operation in the Consolidated Statements of Operations. During the twenty-six weeks ended June 30, 2012, net income was $3.9 million, primarily due to the reclasification of $3.0 million of previously recorded currency translation adjustments from accumulated other comprehensive income to net income as a result of our substantial liquidation of our investment and a deferred tax asset of $0.9 million related to foreign tax credits we expect to utilize in the future.
Based on our current operating plan, we believe that our sources of available capital are adequate to meet our ongoing cash needs for at least the next twelve months.
During the twenty-six weeks ended June 30, 2012, we experienced no material changes to our contractual obligations as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011.
Foreign Currency Fluctuations
In fiscal 2011, approximately 80% of our products were purchased from suppliers in a variety of foreign countries. The products generally are purchased through purchase orders with the purchase price specified in U.S. dollars. Accordingly, we generally do not have exposure to fluctuations in the relationship between the dollar and various foreign currencies between the time of execution of the purchase order and payment for the product. To the extent that the dollar decreases in value to foreign currencies in the future, the price of the product in dollars for new purchase orders may increase.
The largest portion of our overseas purchases comes from China. Since June 2010 the Chinese Yuan has increased approximately 7.2% relative to the U.S. Dollar. A continued increase in the value of the Yuan relative to the U.S. Dollar will likely result in an increase in the cost of products that we purchase from China.
Impact of Inflation
The overall impact of inflation has not resulted in a significant change in labor costs or the cost of general services utilized. The cost of many of the commodities that are used in our products increased during the first six months of fiscal 2011 resulting in higher material costs. In addition, we have periodically experienced increased transportation costs as a result of higher fuel prices over the past two years. We will attempt to offset cost increases by passing along selling price increases to customers, through the use of alternative suppliers and by resourcing purchases to other countries. However there can be no assurance that we will be successful in these efforts.
We have a noncancelable operating lease for our primary operating facility with a partnership in which Steven L. Berman, our Chief Executive Officer, and his family members, are partners. Based upon the terms of the lease, payments in fiscal 2012 will be $1.5 million. Total rental payments to the partnership under the lease arrangement were $1.4 million in fiscal 2011. The lease with the partnership expires December 28, 2012. We are currently pursuing a new lease agreement.
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Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities and the reported amounts of revenues and expenses. We regularly evaluate our estimates and judgments, including those related to the allowance for doubtful accounts, revenue recognition and allowance for customer credits, inventory reserves, goodwill and income taxes. Estimates and judgments are based upon historical experience and on various other assumptions believed to be accurate and reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our significant estimates and judgments used in the preparation of our consolidated financial statements.
Allowance for Doubtful Accounts. The preparation of our financial statements requires us to make estimates of the collectability of our accounts receivable. We specifically analyze accounts receivable and historical bad debts, customer creditworthiness, current economic trends and changes in customer payment patterns when evaluating the adequacy of the allowance for doubtful accounts. A significant percentage of our accounts receivable have been, and will continue to be, concentrated among a relatively small number of automotive retailers and warehouse distributors in the United States. Our five largest customers accounted for 83% and 78% of net accounts receivable as of December 31, 2011 and December 25, 2010, respectively. A bankruptcy or financial loss associated with a major customer could have a material adverse effect on our sales and operating results.
Revenue Recognition and Allowance for Customer Credits. Revenue is recognized from product sales when goods are shipped, title and risk of loss have been transferred to the customer and collection is reasonably assured. We record estimates for cash discounts, product returns and warranties, discounts and promotional rebates in the period of the sale (Customer Credits). The provision for Customer Credits is recorded as a reduction from gross sales and reserves for Customer Credits are shown as a reduction of accounts receivable. Actual Customer Credits have not differed materially from estimated amounts for each period presented. Amounts billed to customers for shipping and handling are included in net sales. Costs associated with shipping and handling are included in cost of goods sold.
Excess and Obsolete Inventory Reserves. We must make estimates of potential future excess and obsolete inventory costs. We provide reserves for discontinued and excess inventory based upon historical demand, forecasted usage, estimated customer requirements and product line updates. We maintain contact with our customer base in order to understand buying patterns, customer preferences and the life cycle of our products. Changes in customer requirements are factored into the reserves as needed.
Goodwill. We assess the qualitative factors which could affect the fair values of our reporting units on an annual basis or more frequently when an indicator of impairment exists. This annual assessment is performed during our fourth fiscal quarter each year. If , during this assessment, we conclude that it is more likely than not that the carrying value of a reporting unit exceeds its fair value, then we would perform the two-step impairment test for that reporting unit.
Income Taxes. We follow the asset and liability method of accounting for deferred income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year and for the change in the deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns. We must make assumptions, judgments and estimates to determine our current provision for income taxes and also our deferred tax assets and liabilities and any valuation allowance to be recorded against a deferred tax asset. Our judgments, assumptions and estimates relative to the current provision for income taxes takes into account current tax laws, our interpretation of current tax laws and possible outcomes of current and future audits conducted by tax authorities. Changes in tax laws or our interpretation of tax laws and the resolution of current and future tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements. Our assumptions, judgments and estimates relative to the value of a deferred tax asset takes into account predictions of the amount and category of future taxable income. Actual operating results and the underlying amount and category of income in future years could render our current assumptions, judgments and estimates of recoverable net deferred taxes inaccurate. Any of the assumptions, judgments and estimates mentioned above could cause our actual income tax obligations to differ from our estimates.
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New and Recently Adopted Accounting Pronouncements
Please refer to Note 12, New and Recently Adopted Accounting Pronouncements, to the Notes to Consolidated Financial Statements.
Our market risk is the potential loss arising from adverse changes in interest rates. Substantially all of our borrowing capacity and our accounts receivable sale programs bear interest at rates tied to LIBOR. Under the terms of our revolving credit facility and customer-sponsored programs to sell accounts receivable, a change in either the lenders base rate, LIBOR or discount rates under our accounts receivable sale programs would affect the rate at which we could access funds thereunder. Hypothetically, a one percentage point increase in LIBOR would increase our interest expense on our variable rate debt, if any, and our financing costs associated with our sales of accounts receivable by approximately $1.6 million annually. This estimate assumes that our variable rate debt balance and the level of sales of accounts receivable remains constant for an annual period and the interest rate change occurs at the beginning of the period. The hypothetical changes and assumptions may be different from what actually occurs in the future.
We have not historically and do not intend to use derivative financial instruments for trading or to speculate on changes in interest rates or commodity prices. We are not exposed to any significant market risks, foreign currency exchange risk or interest rate risk from the use of derivative instruments.
The Company maintains disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) that are designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to the Companys management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
The Companys management, with the participation of the Companys Chief Executive Officer and Chief Financial Officer, under the supervision of the Companys Disclosure Committee, evaluated the effectiveness of the Companys disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, the Companys Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act, were effective as of June 30, 2012.
During the quarter ended June 30, 2012, there were no changes in the Companys internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.
Control systems, no matter how well conceived and operated, are designed to provide a reasonable, but not an absolute, level of assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. The Company conducts periodic evaluations of its internal controls to enhance, where necessary, its procedures and controls.
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We are a party to or otherwise involved in legal proceedings that arise in the ordinary course of business, such as various claims and legal actions involving contracts, competitive practices, patent rights, trademark rights, product liability claims and other matters arising out of the conduct of our business. In the opinion of management, none of the actions, individually or in the aggregate, would likely have a material financial impact on us and we believe the range of reasonably possible losses from current matters continues to be immaterial.
You should carefully consider the factors discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2011, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
Issuer Purchases of Equity Securities
During the thirteen weeks ended June 30, 2012, we purchased shares of our common stock as follows:
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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