Item 7. Management’s Discussion and Analysis
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto that appear elsewhere in this annual report.
Overview
Organization Updates
On December 3, 2018, we completed our acquisition of Krausz Industries Development Ltd. and subsidiaries (“Krausz”), a manufacturer of pipe couplings, grips and clamps with operations in the United States and Israel, for $140.7 million, net of cash acquired, including the assumption and simultaneous repayment of certain debt of $13.2 million. The acquisition of Krausz was financed with cash on hand. The results of Krausz are included within our Infrastructure segment for all periods following the acquisition date.
In October 2019, we acquired the noncontrolling interest of our previously existing joint venture operation for a payment of $5.2 million to our joint venture partner.
Unless the context indicates otherwise, whenever we refer to a particular year, we mean our fiscal year ended or ending September 30 in that particular calendar year.
Business
We operate our business through two segments, Infrastructure and Technologies.
We estimate approximately 60% to 65% of the Company’s 2020 net sales were associated with repair and replacement directly related to municipal water infrastructure spending, approximately 25% to 30% were related to residential construction activity and less than 10% were related to natural gas utilities.
We expect the operating environment to continue to be very challenging, due to the uncertainty around the depth and duration of the pandemic in fiscal 2021. We anticipate that growth in the residential construction end market will help offset anticipated challenges in the project-related portion of the municipal end market.
Infrastructure
Municipal spending in 2020 was impacted by the pandemic in the second half of our year, and although the industry recovered towards the end of our fiscal year as compared with the prior year, uncertainty remains related to the pandemic. According to the U.S. Bureau of Economic Analysis, state and local tax receipts for the quarter ended September 30, 2020 were down year-over-year primarily due to pandemic conditions. According to the U.S. Department of Labor, the trailing twelve-month average consumer price index for water and sewerage rates at September 30, 2020 increased 3.3%. However, water conservation efforts and the economic effects of the pandemic have resulted in lower overall receipts for some U.S. water utilities.
The year-over-year percentage change in housing starts is a key indicator of demand for Infrastructure’s products sold in the residential construction market. In October 2020, Blue Chip Economic Indicators forecasted a 4.5% increase in housing starts for calendar 2021 compared to the prior year.
Technologies
The municipal market is the key end market for Technologies. The businesses in Technologies are primarily project-oriented and depend on customer adoption of their technology-based products and services. We entered 2021 with a backlog of $48.2 million at Mueller Systems, largely for AMI products, some of which will ship in 2022 and beyond.
Consolidated
For our fiscal year 2021, we anticipate that consolidated net sales will be between flat and 3 percent higher than the prior year as we believe that continued strong growth in the residential construction end market will offset any challenges in the project-related areas of our business. In 2020, we benefited from declining costs for raw materials, particularly brass ingot and scrap steel but we expect inflation in raw material costs in 2021.
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Results of Operations
Year Ended September 30, 2020 Compared to Year Ended September 30, 2019
Year ended September 30, 2020
Infrastructure Technologies Corporate Total
(in millions)
Net sales $ 885.5 $ 78.6 $ — $ 964.1
Gross profit 316.4 11.8 — $ 328.2
Operating expenses:
Selling, general and administrative
129.1 24.8 44.5 198.4
Other charges 0.6 0.1 12.3 13.0
129.7 24.9 56.8 211.4
Operating income (loss) $ 186.7 $ (13.1) $ (56.8) 116.8
Pension benefit other than service (3.0)
Interest expense, net 25.5
Walter Energy Accrual 0.2
Income before income taxes 94.1
Income tax expense 22.1
Net income $ 72.0
Year ended September 30, 2019
Infrastructure Technologies Corporate Total
(in millions)
Net sales $ 871.0 $ 97.0 $ — $ 968.0
Gross profit $ 302.9 $ 18.0 $ — $ 320.9
Operating expenses:
Selling, general and administrative
121.3 26.7 34.7 182.7
Gain on sale of idle property (2.4) — — (2.4)
Other charges 1.7 — 14.6 16.3
120.6 26.7 49.3 196.6
Operating income (loss)
$ 182.3 $ (8.7) $ (49.3) 124.3
Pension costs other than service 0.4
Interest expense, net 19.8
Walter Energy Accrual 22.0
Income before income taxes 82.1
Income tax expense 18.3
Net income $ 63.8
Consolidated Analysis
Net sales for 2020 decreased 0.4% to $964.1 million from $968.0 million in the prior year primarily due to lower volume at both segments, which were impacted by the pandemic, partially offset by $18.2 million higher pricing across both segments and the inclusion of first quarter 2020 net sales of Krausz, which we acquired in December of 2018.
Gross profit was $328.2 million for 2020 and $320.9 million in the prior year and gross margin increased to 34.0% in 2020 from 33.2% in the prior year. These increases were primarily due to Krausz gross profit and higher pricing exceeding cost inflation in the current year. Current year g ross profit was reduced by $9.5 million due to pandemic-related costs and production inefficiencies and prior year gross profit was reduced by $6.8 million in Krausz inventory amortization costs.
Selling, general and administrative expenses (“SG&A”) increased 8.6% to $198.4 million for 2020 from $182.7 million in the prior year, and increased 170 basis points to 20.6% of net sales from 18.9% of net sales in the prior year. The increase in SG&A was primarily due to the addition of SG&A of Krausz in the first quarter and increased personnel-related and information technology costs, which were offset by pandemic-driven temporary benefits of $6.8 million resulting from reduced travel, trade show and event spending as well as temporary employee furloughs and temporary salary reductions.
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Other charges for 2020 consisted primarily of costs related to the settlement of the Siemens litigation, our strategic reorganizations, the retirement of an executive, and the acquisition of Krausz. In 2019, other charges consisted primarily of costs related to our previously announced strategic reorganizations, the Aurora tragedy and the acquisition of Krausz, net of a gain on sale of an idle property in Quebec, Canada.
Interest expense, net increased $5.7 million in 2020 from the prior year primarily as a result of reduced interest income due to lower interest rates and a non-cash adjustment to capitalized interest in the current year. The components of interest expense, net are provided below.
2020 2019
(in millions)
5.5% Senior Notes $ 24.8 $ 24.8
Deferred financing costs amortization 1.2 1.2
ABL Agreement 0.6 0.6
Capitalized interest (0.3) (3.0)
Other interest expense (income) 0.3 (0.2)
26.6 23.3
Interest income (1.1) (3.5)
$ 25.5 $ 19.8
Income tax expense of $22.1 million in 2020 was at an effective income tax rate of 23.5%, which was higher than the 22.3% rate in the prior year, which included tax benefits related to the Walter Energy tax matter and U.S. federal transition tax.
Segment Analysis
Infrastructure
Net sales for 2020 increased 1.7% to $885.5 million from $871.0 million in the prior year. Net sales increased primarily due to favorable pricing of $16.6 million and inclusion of first quarter 2020 Krausz net sales, which offset lower organic volume.
Gross profit for 2020 increased 4.5% to $316.4 million from $302.9 million in the prior year primarily due to favorable sales pricing and Krausz gross profit, partially offset by $8.0 million due to pandemic-related costs and production inefficiencies. Gross profit in 2019 was reduced by $6.8 million of Krausz inventory fair value amortization. Gross margin was 35.7% in 2020, a 90 basis point improvement versus 34.8% in the prior year.
SG&A in 2020 increased 6.4% to $129.1 million from $121.3 million in the prior year primarily due to the inclusion of Krausz SG&A in the first quarter and increased personnel-related and information technology costs, which were partially offset by $5.4 million in temporary pandemic-driven savings resulting from reduced travel, trade show and event spending as well as temporary employee furloughs and temporary salary reductions. SG&A was 14.6% and 13.9% of net sales for 2020 and 2019, respectively.
Technologies
Net sales in 2020 decreased to $78.6 million from $97.0 million in the prior year primarily due to lower shipment volumes at both Echologics and Mueller Systems due to timing of large customer orders in the prior year and the effects of the pandemic, which were partially offset by higher prices.
Gross profit in 2020 decreased $6.2 million to $11.8 million from $18.0 million in the prior year. Gross margin decreased to 15.0% in 2020 from 18.6% in the prior year. Gross profit and gross margin were primarily reduced by lower volumes as well as $1.5 million of pandemic-related costs and production inefficiencies.
SG&A decreased to $24.8 million in 2020 from $26.7 million in the prior year primarily due to temporary reduced travel, trade show and event expenses as well as reduced personnel-related expenses. SG&A as a percentage of net sales was 31.6% for 2020 a nd 27.5% in the prior year.
Corporate
SG&A was $44.5 million in 2020 and $34.7 million 2019. SG&A was higher in 2020 due to increased personnel-related costs and information technology costs, which were offset by pandemic-driven benefits resulting from temporary reduced travel, trade show and event spending as well as temporary employee furloughs and temporary salary reductions.
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Year Ended September 30, 2019 Compared to Year Ended September 30, 2018
Management’s Discussion and Analysis comparing the results for the year ended September 30, 2019 to the results for the year ended September 30, 2018 can be found in our Form 10-K for the year ended September 30, 2019.
Financial Condition
Cash and cash equivalents were $208.9 million at September 30, 2020 and $176.7 million at September 30, 2019. Cash and cash equivalents increased during 2020 due to increased cash from operating activities, which benefited from targeted efforts to reduce inventory levels, cost control measures put in place in response to the pandemic, and pandemic-related savings on travel trade show and event spending. These increases were partially offset primarily by capital expenditures of $67.7 million, dividend payments of $33.1 million and settlement of the Walter tax matter of $22.0 million.
Receivables were $180.8 million at September 30, 2020 and $172.8 million million at September 30, 2019. The timing of shipments within each year, primarily within the fourth quarters, primarily caused this increase.
Inventories were $162.5 million at September 30, 2020 and $191.4 million at September 30, 2019. Inventories decreased during 2020 due primarily due to targeted efforts to reduce inventory levels.
Property, plant and equipment, net was $253.8 million at September 30, 2020 and $217.1 million at September 30, 2019, and depreciation expense was $29.6 million in 2020 compared to $26.0 million in 2019. Property, plant and equipment increased primarily due to our previously-announced capital expansion projects in Chattanooga and Kimball, Tennessee and Decatur, Illinois. Capital expenditures, including software development costs capitalized and capitalized interest, were $67.7 million in 2020. Depreciation expense is higher due to the generally higher level of capital expenditures over the last three years.
Intangible assets were $408.9 million at September 30, 2020 and $433.7 million at September 30, 2019. Finite-lived intangible assets, $137.2 million of net book value at September 30, 2020, are amortized over their estimated useful lives, with amortization expense of $28.2 million in 2020 compared to $27.0 million in 2019. We expect amortization expense of these assets will range from approximately $26 million to approximately $28 million in each of the next four years with a decrease to approximately $6 million in fiscal 2025. Indefinite-lived intangible assets, $271.6 million at September 30, 2020, are not amortized, but tested at least annually for possible impairment.
Accounts payable and other current liabilities were $153.9 million at September 30, 2020 and $177.6 million at September 30, 2019. Payables decreased during 2020 due primarily to the settlement of the Walter tax matter and by the timing of other payments.
Outstanding debt was $447.6 million at September 30, 2020 and $446.3 million at September 30, 2019.
Deferred income taxes were net liabilities of $96.3 million at September 30, 2020 and $87.9 million at September 30, 2019. The $8.4 million increase in the net liability was primarily due to reduced deferred tax assets related to inventory and increased deferred tax liabilities related to plant, property and equipment due to tax “bonus depreciation,” net of reductions in deferred tax liabilities related to intangible assets. Net deferred tax liabilities are primarily related to intangible assets.
Liquidity and Capital Resources
We had cash and cash equivalents of $208.9 million at September 30, 2020 and approximately $134 million of additional borrowing capacity under our ABL Agreement based on September 30, 2020 data. Undistributed earnings from our subsidiaries in Israel, Canada and China are considered to be permanently invested outside of the United States. At September 30, 2020, cash and cash equivalents included $18.8 million, $17.0 million, and $6.4 million in Israel, Canada and China, respectively.
Cash flows from operating activities are categorized below.
2020 2019
(in millions)
Collections from customers $ 956.6 $ 966.6
Disbursements, other than interest and income taxes (754.7) (822.8)
Walter tax matter payment (22.0) —
Interest payments, net (24.3) (22.2)
Income tax payments, net (15.3) (29.1)
Cash provided by operating activities $ 140.3 $ 92.5
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We collected $10.0 million less cash from customers in 2020 than in 2019, which was primarily caused by timing of shipments between years as well as the $3.9 million decrease in net sales in 2020 compared with 2019.
We disbursed $46.1 million less cash excluding interest and income taxes in 2020 than in 2019, largely due to our target efforts to reduce inventory, pandemic-related liquidity preservation and cost containment actions such as deferral of some capital expenditures, reduced travel, trade show and spending, and temporary furloughs and temporary salary reductions.
Capital expenditures were $67.7 million during 2020 and $86.6 million during 2019. We estimate 2021 capital expenditures will be between $80 million and $90 million. We expect our capital expenditures will be higher over the next several years as we invest more in our machinery, equipment and facilities for product introductions, enhanced productivity and maintenance. At September 30, 2020, we have completed our large casting foundry in Chattanooga, Tennessee, begun the construction of a new brass foundry in Decatur, Illinois that will replace our existing foundry in Decatur, and are building out our facility in Kimball, Tennessee to leverage our large casting foundry and to insource various parts and components.
Income tax payments were lower during 2020 compared to the prior year primarily because the Walter tax matter, which had been expensed in 2019 for book purposes, was deducted as an expense in determining 2020 taxable income because it was paid in 2020. We expect the effective tax rate in 2021 to be between 24% and 26%.
In 2015, we announced the authorization of a stock repurchase program for up to $50.0 million of our common stock. The program does not commit us to any particular timing or quantity of purchases, and we may suspend or discontinue the program at any time. In 2017, we announced an increase in the authorization of this program to $250 million. We acquired 418,374 and 1,074,234 shares of our common stock in 2020 and 2019, respectively. At September 30, 2020, we had remaining authorization of $145.0 million to repurchase shares of our common stock. We temporarily suspended the share repurchase program in March due to the pandemic; however, we announced in November 2020 that we have ended the suspension.
We anticipate our existing cash, cash equivalents and borrowing capacity combined with our expected operating cash flows will be sufficient to meet our anticipated operating needs, capital expenditures and debt service obligations as they become due through September 30, 2021. However, our ability to make these payments will depend partly upon our future operating performance, which will be affected by general economic, financial, competitive, legislative, regulatory, business and other factors beyond our control.
ABL Agreement
At September 30, 2020, the ABL Agreement consisted of a revolving credit facility for up to $175 million of revolving credit borrowings, swing line loans and letters of credit. The ABL Agreement permits us to increase the size of the credit facility by an additional $150 million in certain circumstances. We may borrow up to $25 million through swing line loans and may have up to $60 million of letters of credit outstanding.
At July 30, 2020, the maturity of the ABL Agreement was extended to July 29, 2025. Borrowings under the amended ABL Agreement bear interest at a floating rate equal to LIBOR plus a margin ranging from 200 to 225 basis points, or a base rate, as defined in the ABL Agreement, plus a margin ranging from 100 to 125 basis points. At September 30, 2020, the applicable LIBOR-based margin was 200 basis points. We pay a commitment fee for any unused borrowing capacity under the amended ABL Agreement of 37.5 basis points annually, on undrawn amounts.
The amended ABL Agreement is subject to mandatory prepayments if total outstanding borrowings under the ABL Agreement are greater than the aggregate commitments under the revolving credit facility or if we dispose of overdue accounts receivable in certain circumstances. The borrowing base under the ABL Agreement is equal to the sum of (a) 85% of the value of eligible accounts receivable and (b) the lesser of (i) 70% of the value of eligible inventory or (ii) 85% of the net orderly liquidation value of the value of eligible inventory, less certain reserves. Prepayments can be made at any time with no penalty.
Substantially all of our U.S. subsidiaries are borrowers under the ABL Agreement and are jointly and severally liable for any outstanding borrowings. Our obligations under the ABL Agreement are secured by a first-priority perfected lien on all of our U.S. inventory, accounts receivable, certain cash and other supporting obligations.
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Borrowings are not subject to any financial maintenance covenants unless excess availability is less than the greater of $17.5 million and 10% of the Loan Cap as defined in the ABL Agreement. The ABL Agreement contains customary negative covenants and restrictions on our ability to engage in specified activities, such as:
• Limitations on other debt, liens, investments and guarantees;
• Restrictions on dividends and redemptions of our capital stock and prepayments and redemptions of debt; and
• Restrictions on mergers and acquisition, sales of assets and transactions with affiliates.
5.5% Senior Unsecured Notes
On June 12, 2018, we privately issued $450.0 million of 5.5% Senior Unsecured Notes (“Notes”), which mature in June 2026 and bear interest at 5.5%, paid semi-annually. Substantially all of our U.S. Subsidiaries guarantee the Notes, which are subordinate to borrowings under the ABL. Based on quoted market prices, the outstanding Notes had a fair value of $465.8 million at September 30, 2020.
An indenture securing the Notes (“Indenture”) contains customary covenants and events of default, including covenants that limit our ability to incur debt, pay dividends, and make investments. We believe we were compliant with these covenants at September 30, 2020 and expect to remain in compliance through September 30, 2021.
We may redeem some or all of the Notes at any time or from time to time prior to June 15, 2021 at certain “make-whole” redemption prices (as set forth in the Indenture) and on or after June 15, 2021 at specified redemption prices (as set forth in the Indenture). Additionally, we may redeem up to 40% of the aggregate principal amount of the Notes at any time or from time to time prior to June 15, 2021 with the net proceeds of specified equity offerings at specified redemption prices (as set forth in the Indenture). Upon a change of control (as defined in the Indenture), we will be required to make an offer to purchase the Notes at a price equal to 101% of the outstanding principal amount of the Notes.
Credit Ratings
Our corporate credit rating and the credit ratings for our debt and outlook are presented below.
Moody’s Standard & Poor’s
September 30, September 30,
2020 2019 2020 2019
Corporate credit rating Ba2 Ba2 BB BB
ABL Agreement Not rated Not rated Not rated Not rated
Notes Ba3 Ba3 BB BB
Outlook Stable Stable Stable Stable
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not have any undisclosed borrowings or debt or any derivative contracts other than those described in “Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK” or synthetic leases. Therefore, we are not exposed to any financing, liquidity, market or credit risk that could have arisen had we engaged in such relationships.
We use letters of credit and surety bonds in the ordinary course of business to ensure the performance of contractual obligations. At September 30, 2020, we had $13.8 million of letters of credit and $42.7 million of surety bonds outstanding.
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Contractual Obligations
Our contractual obligations at September 30, 2020 are presented below.
2021 2022-2023 2024-2025 After 2025 Total
(in millions)
Debt principal payments $ 1.2 $ 1.4 $ 0.1 $ 450.0 $ 452.7
Debt interest payments 24.8 49.6 49.5 24.8 148.7
Operating leases
5.5 9.1 7.8 12.5 34.9
Unconditional purchase obligations (1)
112.4 0.9 — — 113.3
Other current liabilities (2)
— — — — —
$ 143.9 $ 61.0 $ 57.4 $ 487.3 $ 749.6
(1) Includes contractual obligations for purchases of raw materials and capital expenditures.
(2) Consists of obligations for required pension contributions. Actual payments may differ. We have not estimated required pension contributions beyond 2021.
Effect of Inflation
We experience changing price levels primarily related to purchased components and raw materials. Infrastructure experienced a 13% decrease in the average cost per ton of scrap steel and a 9% decrease in the average cost of brass ingot in 2020 compared to 2019. Technologies was also favorably affected by the 9% decrease in the average cost of brass ingot. We anticipate inflation in raw material costs in 2021.
Seasonality
Our water infrastructure business depends on construction activity, which is seasonal in many areas due to the impact of cold weather conditions on construction. Net sales and operating income have historically been lowest in the quarters ending December 31 and March 31 when the northern United States and all of Canada generally face weather conditions that restrict significant construction and other field crew activity. Generally speaking, for Infrastructure, approximately 45% of a fiscal year’s net sales occurs in the first half of the fiscal year with 55% occurring in the second half of the fiscal year, though this pattern was disrupted by the pandemic in 2020. See “Item 1A. RISK FACTORS-Seasonal demand for certain of our products and services may adversely affect our financial results.”
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. These estimates are based upon experience and on various other assumptions we believe to be reasonable under the circumstances. Actual results may differ from these estimates. We consider an accounting estimate to be critical if changes in the estimate that are reasonably likely to occur over time or the use of reasonably different estimates could have a material impact on our financial condition or results of operations. We consider the accounting topics presented below to include our critical accounting estimates.
Revenue Recognition
We recognize revenue when control of promised products or services is transferred to our customers, in amounts that reflect the consideration to which we expect to be entitled in exchange for those products or services. We account for a contract when it has approval and commitment from both parties, the rights of the parties are identified, the payment terms are identified, the contract has commercial substance and collectability of consideration is probable. We determine the appropriate revenue recognition for our contracts with customers by analyzing the type, terms and conditions of each contract or arrangement with a customer. See Note 3. for more information regarding our revenues.
Inventories
We record inventories at the lower of first-in, first-out method cost or estimated net realizable value. Inventory cost includes an overhead component that can be affected by levels of production and actual costs incurred. We evaluate the need to record adjustments for impairment of inventory at least quarterly. This evaluation includes such factors as anticipated usage, inventory levels and ultimate product sales value. If in our judgment persuasive evidence exists that the net realizable value of inventory is lower than its cost, the inventory value is written-down to its estimated net realizable value. Significant judgments regarding future events and market conditions must be made when estimating net realizable value.
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Income Taxes
We recognize deferred tax liabilities and deferred tax assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred tax liabilities and assets are determined based on the differences between the financial statements and the tax basis of assets and liabilities, using enacted tax rates in effect for the years in which the differences are expected to reverse. A valuation allowance is provided to offset any net deferred tax assets when, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. Our tax balances are based on our expectations of future operating performance, reversal of taxable temporary differences, tax planning strategies, interpretation of the tax regulations currently enacted and rulings in numerous tax jurisdictions.
We only record tax benefits for positions that we believe are more likely than not of being sustained under audit examination based solely on the technical merits of the associated tax position. The amount of tax benefit recognized for any position that meets the more likely than not threshold is the largest amount of the tax benefit that we believe is greater than 50% likely of being realized.
Accounting for the Impairment of Long-Lived Assets Including Goodwill and Other Intangible Assets
We test indefinite-lived intangible assets and goodwill for impairment annually (or more frequently if events or circumstances indicate possible impairment). We performed this annual impairment testing at September 1, 2020, using standard valuation methodologies and rates that we considered reasonable, and concluded that our indefinite-lived intangible assets and goodwill were not impaired.
We tested the indefinite-lived intangible assets for impairment using a “royalty savings method,” which is a variation of the discounted cash flow method. This method estimates a fair value by calculating an estimated discounted future cash flow stream from the hypothetical licensing of the indefinite-lived intangible assets. If this estimated fair value exceeds the carrying value, no impairment is indicated. This analysis is dependent on management’s best estimates of future operating results and the selection of reasonable discount rates and hypothetical royalty rates. Significantly different projected operating results could result in different conclusions regarding impairment.
At March 31, 2020, in connection with pandemic-related disruptions on the overall market and our business, we reviewed our indefinite-lived intangible assets and goodwill to determine if possible impairments had been indicated. As a result of this review, we performed a quantitative goodwill impairment assessment of our Krausz reporting unit. The Krausz reporting unit had $85.9 million of goodwill at March 31, 2020. We used a discounted cash flow model to determine the estimated fair value of the reporting unit. We made estimates and assumptions regarding projected operating results, including future revenue, EBITDA margin and long-term growth rates, as well as the discount rate, to estimate the Krausz reporting unit’s fair value. These assumptions represented our best estimates and we believe they were reasonable and appropriate. However, they were forecasts during a complex and still-developing situation with the pandemic, and as such they involved a high degree of uncertainty. The key assumptions used in the March 31 valuation included:
• Our best estimates of revenue and expenses over a 5-year period, which support estimated EBITDA margins.
• Long-term growth of revenue in the model beyond 2025 was 3 percent.
• Long-term growth of free cash flow in the model beyond 2025 was 5 percent.
• The discount rate in the model, which includes a forecast-risk factor, was 12.8 percent.
The results of the quantitative impairment assessment indicated that the Krausz reporting unit’s fair value exceeded its carrying value, which indicated that goodwill was not impaired. However, the excess of the estimated fair value over the carrying value was not significant, the use of different key assumptions could result in a materially different outcome, and we cannot provide assurance that our estimates will be realized.
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We performed a substantially similar goodwill impairment test at September 1 on our Krausz reporting unit with revised forecasts reflective of greater insight into the possible effects the pandemic may have on our operations. The Krausz reporting unit goodwill increased to $87.7 million at September 1, 2020 due to U.S. dollar-Israeli shekel exchange rate fluctuation. We also utilized the “guideline public company” method, which involves comparing the reporting unit to similar companies whose stocks are freely traded on organized exchanges. We weighted the results of the discounted cash flow method and the guideline public company method to conclude on a fair value. The key assumptions used in the September 1 valuation included:
• Our best estimates of revenue and expenses over a 5-year period, which support estimated EBITDA margins.
• Long-term growth of revenue in the model beyond 2025 was 3 percent.
• Long-term growth of free cash flow in the model beyond 2025 was 5 percent.
• The discount rate in the model, which includes a forecast-risk factor, was 13.5 percent.
The results of the quantitative impairment assessment indicated that the Krausz reporting unit’s fair value exceeded its carrying value, which indicated that goodwill was not impaired.
The continuation of pandemic-related effects on our business and the overall market could potentially materially change the key assumptions and lead to future impairment charges.
Other long-lived assets, including finite-lived intangible assets, are amortized over their respective estimated useful lives and reviewed for impairment if events or circumstances indicate possible impairment.
Warranty Costs
We accrue for warranty expenses that can include customer costs of repair and/or replacement, including labor, materials, equipment, freight and reasonable overhead costs. We accrue for the estimated cost of product warranties at the time of sale if such costs are determined to be reasonably estimable at that time. Warranty cost estimates are revised throughout applicable warranty periods as better information regarding warranty costs becomes available. Critical factors in our analyses include warranty terms, specific claim situations, general incurred and projected failure rates, the nature of product failures, product and labor costs, and general business conditions. These estimates are inherently uncertain as they are based on historical data. If warranty claims are made in the current period for issues that have not historically been the subject of warranty claims and were not taken into consideration in establishing the accrual or if claims for issues already considered in establishing the accrual exceed expectations, warranty expense may exceed the accrual for that particular product. Additionally, a significant increase in costs of repair or replacement could require additional warranty expense. We monitor and analyze our warranty experience and costs periodically and may revise our warranty accrual as necessary. However, as we cannot predict actual future claims, the potential exists for the difference in any one reporting period to be material.
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Contingencies
We are involved in litigation, investigations and claims arising out of the normal conduct of our business. We estimate and accrue liabilities resulting from such matters based on a variety of factors, including outstanding legal claims and proposed settlements; assessments by counsel of pending or threatened litigation; and assessments of potential environmental liabilities and remediation costs. We believe we have adequately accrued for these potential liabilities; however, facts and circumstances may change and could cause the actual liability to exceed the estimates, or may require adjustments to the recorded liability balances in the future. As we learn new facts concerning contingencies, we reassess our position both with respect to accrued liabilities and other potential exposures. Estimates particularly sensitive to future changes include liabilities recorded for environmental remediation, tax and legal matters. Estimated future environmental remediation costs are subject to change due to such factors as the uncertain magnitude of cleanup costs, the unknown time and extent of such remedial actions that may be required, and the determination of our liability in proportion to that of other responsible parties. Estimated future costs related to tax and legal matters are subject to change as events evolve and as additional information becomes available during the administrative and litigation processes. For more information on these and other contingencies, see Note 18. of the Notes to Consolidated Financial Statements. See also “Item 1. BUSINESS - Regulatory and Environmental Matters,” “Item 1A. RISK FACTORS” and “Item 3. LEGAL PROCEEDINGS”
Workers Compensation, Defined Benefit Pension Plans, Environmental and Other Long-term Liabilities
We are obligated for various liabilities that will ultimately be determined over what could be very long future time periods. We established the recorded liabilities for such items at September 30, 2020 using estimates for when such amounts will be paid and what the amounts of such payments will be. These estimates are subject to change based on numerous factors, including among others, regulatory changes, technology changes, the investment performance of related assets, longevity of participants, the discount rate used and changes to plan designs.
Business Combinations
We recognize assets acquired and liabilities assumed at their estimated acquisition date fair values, with the excess of purchase price over the estimated fair values of identifiable net assets recorded as goodwill. Assigning fair values requires us to make significant estimates and assumptions regarding the fair value of identifiable intangible assets. We may refine these estimates if necessary over a period not to exceed one year by taking into consideration new information that, if known at the acquisition date, would have affected the fair values recognized for assets acquired and liabilities assumed.
Significant estimates and assumptions are used in estimating the value of acquired identifiable intangible assets, including estimating future cash flows based on forecasted revenues and EBITDA margins that we expect to generate following the acquisition, selecting an applicable royalty rate where needed, applying an appropriate discount rate to estimate a present value of those cash flows and determining their useful lives. These assumptions are forward-looking and could be affected by future economic and market conditions.