Dorman Products, Inc. (DORM) FY 2022 MD&A

Overview

We are one of the leading suppliers of replacement and upgrade parts in the motor vehicle aftermarket industry, serving passenger cars, light-, medium-, and heavy-duty trucks, as well as specialty vehicles, including utility terrain vehicles (UTVs) and all-terrain vehicles (ATVs). As of December 31, 2022, we marketed approximately 129,000 distinct parts compared to approximately 118,000 as of December 25, 2021, many of which we designed and engineered. This number excludes private label stock keeping units and other variations in how we market, package and distribute our products, includes distinct parts of acquired companies and reflects distinct parts that have been discontinued at the end of their lifecycle. Our products are sold under our various brand names, under our customers’ private label brands or in bulk. We are one of the leading aftermarket suppliers of parts that were traditionally available to consumers only from OE manufacturers or salvage yards. These parts include, among other parts, leaf springs, intake manifolds, exhaust manifolds, window regulators, radiator fan assemblies, tire pressure monitor sensors, exhaust gas recirculation (EGR) coolers, UTV windshields, and complex electronics modules.

We generate most of our net sales from customers in North America, primarily in the United States. Our products are sold primarily through aftermarket retailers, including through their online platforms; dealers; national, regional and local warehouse distributors and specialty markets; and salvage yards. We also distribute aftermarket parts outside the United States, with sales primarily into Canada and Mexico, and to a lesser extent, Europe, the Middle East and Australia.

We may experience significant fluctuations from quarter to quarter in our results of operations due to the timing of orders placed by our customers as well as our ability and the ability of our suppliers to deliver products ordered by our customers. The introduction of new products and product lines to customers, as well as business acquisitions, may also cause significant fluctuations from quarter to quarter.

Prior to October 4, 2022, we operated on a 52-53-week period ending on the last Saturday of the calendar year. Our 2022 fiscal year under this schedule is a 53-week period that ended on December 31, 2022 (“fiscal 2022”). Effective October 4, 2022, our Board of Directors approved a change in Dorman’s fiscal year end from the last Saturday in December of each year to December 31 of each year. This change will result in future years ending on December 31, consistent with fiscal 2022. Our fiscal 2021 and fiscal 2020 were 52-week periods that ended on December 25, 2021 (“fiscal 2021”) and December 26, 2020 (“fiscal 2020”), respectively.

Business Performance Summary

Net sales increased 29% to $1,733.7 million in fiscal 2022 from $1,345.2 million in fiscal 2021. Net income decreased 8% to $121.5 million in fiscal 2022 from $131.5 million in fiscal 2021. Additionally, in fiscal 2022 we generated cash flows from operations of $41.7 million and repurchased 180,750 common shares under our share repurchase program for $17.6 million.

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New Product Development

New product development is an important success factor for us and traditionally has been our primary vehicle for growth. We have made incremental investments to increase our new product development efforts to grow our business and strengthen our relationships with our customers. The investments primarily have been in the form of increased product development resources, increased customer and end-user awareness programs, and customer service improvements. These investments historically have enabled us to provide an expanding array of new product offerings and grow revenues at levels that generally have exceeded market growth rates.

In fiscal 2022, we introduced 4,443 new distinct parts to our customers and end-users, including 1,565 “New-to-the-Aftermarket” parts. Please see ITEM 1, “Business – Product Development” for a year-over-year comparison of new product introductions.

One area of focus has been our complex electronics program, which capitalizes on the growing number of electronic components being utilized on today’s OE platforms. New vehicles contain an average of approximately 50 electronic modules, with some high-end luxury vehicles containing over 100 modules. Our complex electronics products are designed and developed in-house and tested to help ensure consistent performance, and our product portfolio is focused on further developing our leadership position in the category.

Another area of focus has been on products we market for the medium- and heavy-duty truck sector of the motor vehicle aftermarket industry. We believe that this sector provides many of the same opportunities for growth that the passenger car and light-duty truck sector of the motor vehicle aftermarket industry has provided us. We specialize in offering heavy-duty parts that were traditionally only available from OE manufacturers or salvage yards, similar to how we approach the passenger car and light-duty truck sector. During fiscal 2022, we introduced 486 distinct parts in this product line. We expect to continue to invest in the medium- and heavy-duty product category, as evidenced by our acquisition of Dayton Parts in fiscal 2021.

Acquisitions

A key component of our strategy is growth through acquisitions. On October 4, 2022, we acquired Super ATV, a leading independent supplier to the powersports aftermarket with a family of highly respected brands spanning functional accessories and upgrades, as well as replacement parts for specialty vehicles. On August 10, 2021, we acquired Dayton Parts, a manufacturer of chassis and other parts designed to serve the heavy-duty vehicle sector of the aftermarket. See Note 2, Business Acquisitions and Investments under Notes to Condensed Consolidated Financial Statements for additional information. We may acquire businesses in the future to supplement our financial growth, increase our customer base, add to our distribution capabilities or enhance our product development resources, among other reasons.

Economic Factors

The Company’s financial results are also impacted by various economic and industry factors, including, but not limited to the number, age and condition of vehicles in operation at any one time, and the miles driven by those vehicles.

Vehicles in Operation

The Company’s products are primarily purchased and installed on a subsegment of the passenger and light-duty vehicles in operation in the United States (“VIO”), specifically weighted towards vehicles aged 8 to 13 years old. Each year, the United States seasonally adjusted annual rate (“US SAAR”) of new vehicles purchased adds a new year to the VIO. According to data from the Auto Care Association (“Auto Care”), the US SAAR experienced a decline from 2008 to 2011 as consumers purchased fewer new vehicles as a result of the Great Recession of 2008. We believe that the declining US SAAR during that period resulted in a follow-on decline in our primary VIO subsegment (8 to 13-year-old vehicles) commencing in 2016. However, following 2011 and the impact of the Great Recession of 2008, U.S. consumers began to increase their purchases of new vehicles which over time caused the US SAAR to recover and return to more historical levels. Consequently, we expect the VIO for vehicles aged 8 to 13 years old to continue to recover over the next several years. Additionally, during 2023, we expect fewer new vehicles to be purchased in the near term, benefiting demand for aftermarket parts, given the lack of availability of new vehicles and increased interest rates.

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In addition, we believe that vehicle owners generally are operating their current vehicles longer than they did several years ago, performing necessary repairs and maintenance to keep those vehicles well maintained. We believe this trend has supported an increase in VIO, which increased to 293.4 million, a 1% increase in 2022 over 2021. According to data published by Polk, a division of IHS Automotive, the average age of VIO increased to 12.4 years as of October 2022 from 12.2 years as of October 2021 despite increasing new car sales.

Miles Driven

The number of miles driven is another important statistic that impacts our business. Generally, as vehicles are driven more miles, the more likely it is that parts will fail and there will be increased demand for replacement parts, including our parts. According the U.S. Department of Transportation, the number of miles driven through October 2022 increased 1.5% year over year. We expect this increase in miles driven may continue, given that certain employers have begun to lift work-from-home policies implemented during the pandemic and, consequently, consumers may return to commuting to work on a more regular basis. However, global gasoline prices have been volatile in recent months, which may negatively impact miles driven as consumers reduce travel or seek alternative methods of transportation.

Brand Protection

We operate in a highly competitive market. As a result, we are continuously evaluating our approach to brand, pricing and terms to our different customers and channels. For example, we maintain a brand protection policy, which is designed to ensure that certain products bearing the Dorman name are not advertised below certain approved pricing levels. In addition, we pursue legal remedies when we see third parties, such as e-commerce retailers, violating our intellectual property rights by wrongfully representing our products as their own or using our product images for their own marketing efforts.

Discounts, Allowances, and Incentives

We offer a variety of customer discounts, rebates, defective and slow-moving product returns and other incentives. We may offer cash discounts for paying invoices in accordance with the specified discount terms of the invoice. In addition, we may offer pricing discounts based on volume purchased from us or other pricing discounts related to programs under a customer’s agreement. These discounts can be in the form of “off-invoice” discounts and are immediately deducted from sales at the time of sale. For those customers that choose to receive a payment on a quarterly or annual basis instead of “off-invoice,” we accrue for such payments as the related sales are made and reduce sales accordingly. Finally, rebates and discounts are provided to customers to support promotional activities such as advertising and sales force allowances.

Our customers, particularly our larger retail customers, regularly seek more favorable pricing and product return provisions, and extended payment terms when negotiating with us. We attempt to avoid or minimize these concessions as much as possible, but we have granted pricing concessions, indemnification rights, extended customer payment terms, and allowed a higher level of product returns in certain cases. These concessions impact net sales as well as our profit levels and may require additional capital to finance the business. We expect our customers to continue to exert pressure on our margins.

New Customer Acquisition Costs

We may incur new customer acquisition costs where we incur change-over costs to induce a customer to switch from a competitor’s brand, including expanding new product lines into our existing customers. Change-over costs include the costs related to removing the new customer’s inventory and replacing it with our inventory, which is commonly referred to as a stock lift. New customer acquisition costs are recorded as a reduction to revenue when incurred.

Product Warranty and Overstock Returns

Many of our products carry a lifetime limited warranty, which generally covers defects in materials or workmanship and failure to meet specifications. In addition to warranty returns, we also may permit our customers to return new, undamaged products to us within customer-specific limits if they have overstocked their inventories. At the time products are sold, we accrue a liability for product warranties and overstock

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returns as a percentage of sales based upon estimates established using historical information on the nature, frequency and average cost of the claim and the probability of the customer return. Significant judgments and estimates must be made and used in connection with establishing the sales returns and other allowances in any accounting period. Revision to these estimates is made when necessary, based upon changes in these factors. We regularly study trends of such claims.

Foreign Currency

Our products are purchased from suppliers in the United States and a variety of non-U.S. 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 U.S. dollar and various foreign currencies between the time of execution of the purchase order and payment for the product.

To the extent that the U.S. dollar changes in value relative to those foreign currencies in the future, the prices charged by our suppliers for products under new purchase orders may change in equivalent U.S. dollars. The largest portion of our overseas purchases comes from China. The Chinese yuan to U.S. dollar exchange rate has fluctuated over the past several years. Any future changes in the value of the Chinese yuan relative to the U.S. dollar may result in a change in the cost of products that we purchase from China. However, the cost of the products we procure is also affected by other factors including raw material availability, labor cost, and transportation costs.

Since our consolidated financial statements are denominated in U.S. dollars, the assets, liabilities, net sales, and expenses that are denominated in currencies other than the U.S. dollar must be converted into U.S. dollars using exchange rates for the current period. As a result, fluctuations in foreign currency exchange rates may impact our financial results.

Impact of Labor Market and Inflationary Costs

We have experienced broad-based inflationary impacts during the year ended December 31, 2022, due primarily to global transportation and logistics constraints, which have resulted in significantly higher transportation costs; tariffs; material costs; and wage inflation from an increasingly competitive labor market. We expect increased freight, higher labor costs and material inflation costs to continue to negatively impact our results through fiscal 2023, despite recent signs of global supply chain constraints easing, which could lead to lower ocean freight and commodity costs. We attempt to offset inflationary pressures with cost-saving initiatives, price increases to customers and the use of alternative suppliers. Although we have implemented pass-through price increases to offset inflationary cost impacts, the price increases have often been implemented after we have experienced higher costs resulting in a lag effect to the full recovery of these costs. Furthermore, pricing increases that we implemented to pass through the increased costs had no added profit dollars and consequently did not fully offset the impact that the increased costs had on our gross and operating margin percentages. There can be no assurance that we will be successful in implementing pricing increases in the future to recover increased inflationary costs.

Impact of Interest Rates

Our business is subject to interest rate risk under the terms of our customer accounts receivable sales programs, as a change in the Term Secured Overnight Financing Rate (“Term SOFR”), or alternative discount rate affects the cost incurred to factor eligible accounts receivable. Additionally, our outstanding borrowings under our credit facility bear interest at variable rates tied to Term SOFR, or the applicable base rate. Under the terms of the credit facility, a change in interest rates affects the rate at which we can borrow funds thereunder and also impacts the interest cost on existing borrowings. During the year ended December 31, 2022, we saw significant increases in Term SOFR, and other reference rates, which impacted our results as discussed in Results of Operations that follows. We expect interest rates may continue to increase in the foreseeable future, increasing the costs associated with our accounts receivable sales programs and outstanding borrowings.

Impact of Tariffs

In the third quarter of 2018, the Office of the United States Trade Representative (USTR) began imposing additional tariffs on products imported from China, including many of our products, ranging from

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7.5% to 25%. The tariffs enacted to date increase the cost of many of the products that are manufactured for us in China. We have taken several actions to mitigate the impact of the tariffs including, but not limited to, price increases to our customers and cost concessions from our suppliers. We expect to continue mitigating the impact of tariffs primarily through selling price increases to offset the higher tariffs incurred. Tariffs are not expected to have a material impact on our net income but are expected to increase net sales and lower our gross and operating profit margins.

In January 2020, the USTR granted temporary tariff relief for certain categories of products being imported from China. The tariff relief granted by the USTR expired on most categories of products being imported from China at the end of 2020. However, in March 2022, the USTR reinstated tariff relief for certain categories of products imported from China. The reinstated tariff relief applied retroactively to October 12, 2021 and is scheduled to expire on September 30, 2023. The reinstated tariff relief applies to a limited number of our products and is not expected to materially impact our operating results.

Results of Operations

The following table sets forth, for the periods indicated, the dollar value and percentage of net sales represented by certain items in our Consolidated Statements of Operations:

*Percentage of sales information may not add due to rounding

Fiscal Year Ended December 31, 2022 Compared to Fiscal Year Ended December 25, 2021

Net sales increased 29% to $1,733.7 million in fiscal 2022 from $1,345.2 million in fiscal 2021. The increase in net sales reflected a full year of results from Dayton Parts, which was acquired in August 2021; a continuation of favorable underlying industry dynamics across our customer channels; increased new product launches; price increases to offset inflationary costs; the acquisition of SuperATV in October 2022; and the benefit of an extra week in fiscal 2022. Year-over-year net sales growth for fiscal 2022 excluding Dayton Parts and SuperATV was 13.8%.

Gross profit margin was 32.6% of net sales in fiscal 2022 compared to 34.4% of net sales in fiscal 2021. Gross margin contraction was driven by broad-based cost pressures due to global supply chain constraints as well as commodity and wage rate inflation. We continued to implement price increases and cost-savings initiatives to offset the inflationary cost pressures experienced during the period, which maintained gross profit dollars but resulted in a lower gross margin percentage.

Selling, general and administrative expenses were $393.4 million, or 22.7% of net sales, in fiscal 2022 compared to $291.4 million, or 21.7% of net sales, in fiscal 2021. The increase in SG&A as a percentage of net sales was primarily due to the impact of higher interest rates on our customer accounts receivable factoring programs and higher amortization of intangible assets resulting from the Dayton Parts acquisition in August 2021 and the SuperATV acquisition in October 2022, partially offset by operating leverage from the increase in net sales in fiscal 2022 as compared to fiscal 2021. SG&A expenses as a percentage of net sales also increased as a result of the transaction expenses associated with the acquisition of SuperATV in fiscal 2022.

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Our effective tax rate decreased to 22.2% in fiscal 2022 from 22.5% in fiscal 2021. The lower effective tax rate in 2022 was the result of an increase to the acquired Dayton Parts net operating loss deferred tax asset and favorable provision-to-return items, offset by an increase in state tax expense.

Liquidity and Capital Resources

Historically, our primary sources of liquidity have been our invested cash and the cash flow we generate from our operations, including accounts receivable sales programs provided by certain customers. Cash and cash equivalents at December 31, 2022 decreased to $46.0 million from $58.8 million at December 25, 2021. Working capital was $590.8 million at December 31, 2022 compared to $411.5 million at December 25, 2021. Shareholders’ equity was $1,042.6 million at December 31, 2022 and $932.7 million at December 25, 2021.

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. However, our liquidity could be negatively affected by extending payment terms to customers, a decrease in demand for our products, the outcome of contingencies or other factors. See Note 10, “Commitments and Contingencies”, in the accompanying consolidated financial statements for additional information regarding commitments and contingencies that may affect our liquidity.

Tariffs

Tariffs increase our use of cash since we pay for the tariffs upon the arrival of our goods in the United States but collect the cash on any passthrough price increases from our customers on a delayed basis according to the payment terms negotiated with our customers.

Payment Terms and Accounts Receivable Sales Programs

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. We participate in accounts receivable sales programs with several customers that allow us to sell our accounts receivable to financial institutions to offset the negative cash flow impact of these payment term extensions. However, any sales of accounts receivable through these programs ultimately result in us receiving a lesser amount of cash upfront than if we collected those accounts receivable ourselves in due course, resulting in accounts receivable factoring costs. Moreover, to the extent that any of these accounts receivable sales programs bear interest rates tied to the Term SOFR, or other reference rates, increases in these applicable rates increase our cost to sell our receivables and reduce the amount of cash we receive. See ITEM 7A, “Quantitative and Qualitative Disclosures about Market Risk” for more information.

During fiscal 2022 and fiscal 2021, we sold approximately $1,048.7 million and $935.8 million, respectively, under these programs. If receivables had not been sold, $722.3 million and $598.8 million of additional receivables would have been outstanding at December 31, 2022 and December 25, 2021, respectively, based on standard payment terms. We had capacity to sell more accounts receivable under these programs if the needs of the business warranted. Further extensions of customer payment terms would result in additional uses of cash or increased costs associated with the sales of accounts receivable.

During the years ended December 31, 2022 and December 25, 2021, factoring costs associated with these accounts receivable sales programs were $37.2 million and $11.7 million, respectively. The increase in factoring costs year over year was primarily driven by higher Term SOFR and other reference rates, and higher accounts receivable sold under these programs.

Credit Agreement

On August 10, 2021, in connection with the acquisition of Dayton Parts, we entered into a credit agreement that provided for a $600.0 million revolving credit facility, including a letter of credit sub-facility of up to $60 million (the “2021 Facility”). The 2021 Facility replaced our previous $100.0 million revolving credit facility. The 2021 Facility was scheduled to mature on August 10, 2026, was guaranteed by the Company’s material domestic subsidiaries (together with the Company, the “Credit Parties”) and was supported by a security interest in substantially all of the Credit Parties’ personal property and assets, subject to certain exceptions.

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On October 4, 2022, Dorman entered into an amendment and restatement of the 2021 Facility (as amended and restated, the “New Facility”) by and among Dorman, the lenders from time to time party thereto, and the administrative agent. In addition to including the existing $600.0 million revolving facility, the New Facility includes a $500.0 million term loan, which was used to fund the SuperATV acquisition. The New Facility (including the revolving portion of the New Facility) matures on October 4, 2027, is guaranteed by the Credit Parties and is supported by a security interest in substantially all of the Credit Parties’ personal property and assets, subject to certain exceptions.

As of December 31, 2022, we were not in default with respect to the New Facility. As of December 31, 2022, there was $239.4 million in outstanding borrowings under the revolver, and $496.9 million in outstanding borrowings under the term loan portions of the New Facility, and as of such date we had three outstanding letters of credit for $1.0 million in the aggregate. Net of outstanding borrowings and letters of credit, we had $362.7 million available under the New Facility at December 31, 2022.

Refer to Note 2, “Business Acquisitions and Investments,” in the Notes to the Consolidated Financial Statements for additional information.

Refer to Note 7, Long-Term Debt under Notes to Consolidated Financial Statements for additional information regarding the New Facility

Cash Flows

Below is a table setting forth the key lines of our Consolidated Statements of Cash Flows:

During fiscal 2022, cash provided by operating activities was $41.7 million compared to $100.3 million during fiscal 2021. The $58.7 million decrease was driven by higher cash outflows for working capital. The cash outflows for working capital were primarily driven by higher inventory purchases to meet demand and provide safety stock due to global supply chain constraints, partially offset by the benefits of accounts receivable collections from higher factoring.

Investing activities used $526.8 million and $365.3 million of cash in fiscal 2022 and 2021 respectively.

•During fiscal 2022, we used $489.0 million to acquire SuperATV, net of cash acquired, and during fiscal 2021, we used $345.5 million to acquire Dayton Parts, net of cash acquired.

•Capital spending in fiscal 2022 totaled $37.9 million and primarily consisted of tooling associated with new products, enhancements and upgrades to our information systems and infrastructure, scheduled equipment replacements, certain facility improvements and other capital projects, including the opening of a new leased distribution center in Whiteland, Indiana.

•Capital spending in fiscal 2021 totaled $19.8 million and primarily consisted of tooling associated with new products, enhancements and upgrades to our information systems and infrastructure, scheduled equipment replacements, certain facility improvements and other capital projects.

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Financing activities provided cash of $472.5 million in fiscal 2022 and used cash of $168.2 million in fiscal 2021.

•During fiscal 2022, we borrowed $500.0 million under the New Facility to help fund the acquisition of SuperATV in October 2022, and subsequently repaid $3.1 million of that borrowing in December 2022. Additionally, during fiscal 2022, we paid $17.6 million to repurchase 180,750 common shares under our share repurchase plan.

•During fiscal 2021, we borrowed $252.4 million under the Prior Facility to help fund the acquisition of Dayton Parts in August 2021, and subsequently repaid $13.0 million of that borrowing during fiscal 2021. Additionally, during fiscal 2021, we paid $61.5 million to repurchase 604,628 common shares under our share repurchase plan.

•The remaining uses of cash from financing activities in each period resulted from stock compensation plan activity and the repurchase of shares of our common stock held in a fund under our 401(k) Plan. Plan participants can no longer purchase shares of Dorman common stock as an investment option under the 401(k) Plan. Shares are generally purchased from the 401(k) Plan when participants sell units as permitted by the 401(k) Plan or elect to leave the 401(k) Plan upon retirement, termination or other reasons.

Off-Balance Sheet Arrangements

Off-balance sheet arrangements are transactions, agreements, or other contractual arrangements with an unconsolidated entity for which we have an obligation to the entity that is not recorded in our consolidated financial statements. We historically have not utilized off-balance sheet financial instruments, and currently do not plan to utilize off-balance sheet arrangements in the future to fund our working capital requirements, operations or growth plans.

We may issue standby letters of credit under our credit agreement. Letters of credit totaling $1.0 million were outstanding at December 31, 2022 and $0.8 million were outstanding at December 25, 2021. Those letters of credit are issued primarily to satisfy the requirements of workers compensation, general liability and other insurance policies. Each of the outstanding letters of credit has a one-year term from the date of issuance.

We do not have any off-balance sheet financing that has, or is reasonably likely to have, a material, current or future effect on our financial condition, revenues, expenses, cash flows, results of operations, liquidity, capital expenditures or capital resources.

Related-Party Transactions

We have two non-cancelable operating leases for operating facilities from companies in which Steven L. Berman, our Executive Chairman, and his family members are owners. Total annual rental payments each year to those companies under the lease arrangements were $2.5 million and $2.3 million in fiscal 2022 and fiscal 2021, respectively.

We are a partner in a joint venture with one of our suppliers and own minority interest investments in two other suppliers. Purchases from these companies were $24.9 million and $18.9 million in fiscal 2022 and fiscal 2021, respectively.

Critical Accounting Policies and Estimates

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, judgments and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities and the reported amounts of revenues and expenses. 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 due to different assumptions or conditions. The following areas all require the use of subjective or complex estimates, judgments and assumptions.

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Revenue Recognition and Accrued Customer Rebates and Returns. Revenue is recognized from product sales when goods are shipped, title and risk of loss and control have been transferred to the customer and collection is reasonably assured. We record estimates for cash discounts, defective and slow-moving product returns, promotional rebates, core return deposits, and other discounts 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 an increase of accrued customer rebates and returns, which is included in current liabilities. Customer Credits are estimated based on contractual provisions, historical experience, and our assessment of current market conditions. Historically, actual Customer Credits have not differed materially from estimated amounts. 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 to understand buying patterns, customer preferences and the life cycle of our products. Changes in customer requirements are factored into the reserves, as needed.

Purchase Accounting. The purchase price of an acquired business is allocated to the underlying tangible and intangible assets acquired and liabilities assumed based upon their respective fair market values, with any excess recorded as goodwill. Such fair market value assessments require judgments and estimates which may change over time and may cause the final amounts to differ materially from original estimates. Any adjustments to fair value assessments are recorded to goodwill over the purchase price allocation period which cannot exceed twelve months from the date of acquisition. Refer to Note 2 to the Consolidated Financial Statements for additional information.