Hillman Solutions Corp. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Income Taxes

Income Taxes

12 Months Ended

Dec. 28, 2019

Loss before income taxes are comprised of the following components for the periods indicated:



	Year Ended December 28, 2019			Year Ended December 29, 2018			Year Ended December 30, 2017
	Year Ended December 28, 2019			Year Ended December 29, 2018			Year Ended December 30, 2017
United States based operations	$	(101,197	)	$	(53,254	)	$	(24,624	)
Non-United States based operations	(7,559		)	(14,317		)	(1,639		)
Loss before income taxes	$	(108,756	)	$	(67,571	)	$	(26,263	)

Below are the components of the Company's income tax (benefit) provision for the periods indicated:



	Year Ended December 28, 2019			Year Ended December 29, 2018			Year Ended December 30, 2017
	Year Ended December 28, 2019			Year Ended December 29, 2018			Year Ended December 30, 2017
Current:
Federal & State	$	1,235		$	263		$	164
Foreign	611			67			814
Total current	1,846			330			978
Deferred:
Federal & State	(23,675		)	(11,679		)	(85,461		)
Foreign	(2,625		)	(4,741		)	(1,989		)
Total deferred	(26,300		)	(16,420		)	(87,450		)
Valuation allowance	19,084			18,160			1,561
Income tax expense/(benefit)	$	(5,370	)	$	2,070		$	(84,911	)

The Company has U.S. federal net operating loss (“NOL”) carryforwards totaling $149,754 as of December 28, 2019 that are available to offset future taxable income. These carryforwards expire from 2027 to 2038. Approximately $59,611 of the U.S. federal NOLs were acquired with the MinuteKey purchase in 2018. The MinuteKey NOLs are subject to limitation under IRC §382 from current and prior ownership changes. The Company noted that $2,503 of the MinuteKey NOLs are expected to expire prior to their utilization and has recorded a valuation allowance of $526 for the MinuteKey NOLs. In addition, the Company's foreign subsidiaries have NOL carryforwards aggregating $27,008. A portion of these carryforwards expire from 2035 to 2039. Management anticipates utilizing all foreign NOLs prior to their expiration.

The Company has state NOL carryforwards with an aggregate tax benefit of $5,426 which expire from 2019 to 2039. The Company has recorded a valuation allowance of $2,709 in fiscal 2019 for the state NOLs expected to expire prior to utilization.

The Company has $908 of general business tax credit carryforwards which expire from 2019 to 2039. A valuation allowance of $287 has been maintained for a portion of these tax credits. The Company has $822 of foreign tax credit carryforwards which expire from 2019 to 2025. A valuation allowance of $822 has been established for these credits given insufficient foreign source income projected to utilize these credits.

The table below reflects the significant components of the Company's net deferred tax assets and liabilities at December 28, 2019 and December 29, 2018:



	As of December 28, 2019			As of December 29, 2018
	Non-current			Non-current
Deferred Tax Asset:
Inventory	$	10,043		$	12,798
Bad debt reserve	868			838
Casualty loss reserve	498			405
Accrued bonus / deferred compensation	5,174			3,517
Deferred rent	80			995
Derivative security value	845			362
Interest limitation	30,533			14,187
Lease liabilities	16,487			—
Deferred revenue - shipping terms	315			301
Medical insurance reserve	—			12
Original issue discount amortization	3,372			3,649
Transaction costs	2,302			2,301
Federal / foreign net operating loss	38,478			47,171
State net operating loss	5,426			6,650
Tax credit carryforwards	2,636			4,984
All other	401			36
Gross deferred tax assets	117,458			98,206
Valuation allowance for deferred tax assets	(34,877		)	(24,993		)
Net deferred tax assets	$	82,581		$	73,213
Deferred Tax Liability:
Intangible asset amortization	$	227,007		$	238,929
Property and equipment	34,218			34,327
Lease assets	16,473			—
All other items	618			653
Deferred tax liabilities	$	278,316		$	273,909
Net deferred tax liability	$	195,735		$	200,696

Realization of the net deferred tax assets is dependent on the reversal of deferred tax liabilities and generating sufficient taxable income prior to their expiration. Although realization is not assured, management estimates it is more likely than not that the net deferred tax assets will be realized. The amount of net deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward periods are reduced. In 2019, the Company established a valuation allowance in the amount of $16,720 against the portion of interest expense that is not currently deductible for domestic federal income tax due to the Tax Cuts and Jobs Act of 2017 ("2017 Tax Act") effective for the first year beginning after December 31, 2017. In addition, the Company established a valuation allowance of $2,709 on U.S. state NOLs due to the Company's inability to utilize the losses prior to expiration. Lastly, the Company liquidated its Luxembourg entity as of December 28, 2019 and is no longer reporting the Company's $23,600 of dual consolidated losses that were subject to a full valuation allowance. With this liquidation, the Company removed $9,579 from the cumulative valuation allowance for deferred tax assets.

Hillman considers the earnings of certain non-U.S. subsidiaries to be indefinitely invested outside the United States on the basis of estimates that future domestic cash generation will be sufficient to meet future domestic cash needs and our specific plans for reinvestment of those subsidiary earnings. The Company has not recorded a deferred tax liability related to the U.S. federal and state income taxes and foreign withholding taxes of undistributed earnings of foreign subsidiaries indefinitely invested outside the United States. Should management decide to repatriate the foreign earnings, the Company would need to adjust the income tax provision in the period the earnings will no longer be indefinitely invested outside the United States.

Below is a reconciliation of statutory income tax rates to the effective income tax rates for the periods indicated:



	Year Ended December 28, 2019		Year Ended December 29, 2018		Year Ended December 30, 2017
Statutory federal income tax rate	21.0	%	21.0	%	35.0	%
Non-U.S. taxes and the impact of non-U.S. losses for which a current tax benefit is not available	0.3	%	0.9	%	6.9	%
State and local income taxes, net of U.S. federal income tax benefit	3.9	%	(0.5	)%	3.4	%
Change in valuation allowance and other items	(18.9	)%	(21.7	)%	(6.5	)%
Adjustment for change in tax law	—	%	(0.9	)%	281.4	%
Adjustment of unrecognized tax benefits	—	%	—	%	1.4	%
Permanent differences:
Acquisition and related transaction costs	—	%	(2.7	)%	—	%
Meals and entertainment expense	(0.2	)%	(0.3	)%	(0.9	)%
Reconciliation of tax provision to return	(0.2	)%	—	%	1.7	%
Reconciliation of other adjustments	(1.0	)%	1.1	%	0.9	%
Effective income tax rate	4.9	%	(3.1	)%	323.3	%

The Company's reserve for unrecognized tax benefits remains unchanged for the year ended December 28, 2019. A balance of $1,101 of unrecognized tax benefit is shown in the financial statements at December 28, 2019 as a reduction of the deferred tax asset for the Company's NOL carryforward.

The following is a summary of the changes for the periods indicated below:



	Year Ended December 28, 2019		Year Ended December 29, 2018		Year Ended December 30, 2017
Unrecognized tax benefits - beginning balance	$	1,101	$	1,101	$	2,060
Gross increases - tax positions in current period	—		—		—
Gross increases - tax positions in prior period	—		—		—
Gross decreases - tax positions in prior period	—		—		(959		)
Unrecognized tax benefits - ending balance	$	1,101	$	1,101	$	1,101
Amount of unrecognized tax benefit that, if recognized would affect the Company's effective tax rate	$	1,101	$	1,101	$	1,101

Tax Cuts and Jobs Act (the "2017 Tax Act")

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“2017 Tax Act”) was signed into law making significant changes to the Internal Revenue Code. Changes include, among other things, a permanent corporate rate reduction to 21% requiring a remeasurement of the Company’s U.S. net deferred tax liabilities, a change in U.S. international taxation to a modified territorial system including a mandatory deemed repatriation on certain unrepatriated earnings of foreign subsidiaries (“Transition Tax”), and providing for additional first-year depreciation that allows full expensing of qualified property placed into service after September 27, 2017.

During 2017, the Company recorded a provisional $75,000 deferred income tax benefit associated with the provisions of the 2017 Tax Act based on currently available information. The Company did not record a provision for the Transition Tax in 2017 given the lack of historical earnings in the Company's foreign subsidiaries. Additionally, the Company recorded a provisional

$807 valuation allowance on its foreign tax credit deferred tax asset given insufficient foreign source income projected to utilize the credits. The Company did not significantly adjust the estimate from the 2017 provisional calculations.

During 2018, the Company became subject to additional provisions of the 2017 Tax Act including computations related to Global Intangible Low Taxed Income ("GILTI") and the IRC §163(j) interest limitation (Interest Limitation). In 2019, our effective tax rate includes $16,720 in income tax expense, a (15.4)% impact to the effective tax rate, related to the Interest Limitation. Our 2018 effective tax rate includes the impact both GILTI and the Interest Limitation, which was approximately $11,700 in income tax expense, a (17.3)% impact to the effective tax rate.

The Company files a consolidated income tax return in the U.S. and numerous consolidated and separate income tax returns in various states and foreign jurisdictions. The Company is not under any significant audits for the period ended December 28, 2019.