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 related notes included in Item 8. “Financial Statements and Supplementary Data” of this Annual Report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and other factors that may cause actual results to differ materially from those projected in any forward-looking statements, as discussed in “Disclosure Regarding Forward-Looking Statements.” These risks and uncertainties include but are not limited to those set forth in “Item 1A. RISK FACTORS” .
Overview
Business
We operate our business through two segments, Infrastructure and Technologies.
We estimate approximately 60% to 65% of the Company’s 2021 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.
In 2021, both Infrastructure and Technologies were impacted by raw material and other cost inflation, supply chain disruptions and labor availability challenges.
We expect the operating environment to continue to be very challenging in 2022, as a result of the uncertainty around the depth and duration of the pandemic. We may continue to be impacted by raw material and other cost inflation, supply chain disruptions and labor availability challenges. While we expect that the municipal repair and replacement activity and new residential construction end markets will remain healthy in 2022, we do anticipate that growth will slow down relative to the strong recovery experienced during 2021. In 2022, we believe that supply chain disruptions could extend overall build cycles for new residential construction, including lot development.
Infrastructure
After experiencing challenges in 2020 resulting from the pandemic, municipal spending in 2021 recovered during the fiscal year as compared with the prior year. According to the United States Department of Labor, the trailing twelve-month average consumer price index for water and sewerage rates at September 30, 2021 increased 3.0%. While the economic effects of the pandemic have impacted revenues for some water utilities in the United States, the economic recovery enabled water utilities to maintain repair and replacement activities. While uncertainty related to the pandemic continues to impact the operating environment, residential construction activity was very strong in 2021 after recovering in 2020. 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. The strength of the residential construction activity during 2021 was reflected in total housing starts in the United States increasing approximately 18%. In October 2021, Blue Chip Economic Indicators forecasted a 1.3% decrease in housing starts for the calendar year 2022 compared to the calendar year 2021.
Technologies
The municipal water market is the key end market for Technologies. As compared with Infrastructure products, Technologies products and services are primarily project-oriented and often depend on customer adoption of our technology-based products and services.
Consolidated
For our fiscal year 2022, we anticipate that consolidated net sales will be 4% to 8% higher than our fiscal year 2021 driven by the benefits of higher pricing and increased shipment volumes, resulting from modest growth in our end markets and our ability to deliver the backlog at Infrastructure and Technologies. In 2021, we encountered increased material costs as a result of higher raw material prices, particularly brass ingot and scrap steel, as well as higher freight, labor costs and energy expenses. In 2022, we anticipate that inflation will continue to lead to higher costs.
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Results of Operations
Year Ended September 30, 2021 Compared to Year Ended September 30, 2020
Year ended September 30, 2021
Infrastructure Technologies Corporate Total
(in millions)
Net sales $ 1,022.0 $ 89.0 $ — $ 1,111.0
Gross profit 345.0 13.5 — $ 358.5
Operating expenses:
Selling, general and administrative
141.0 26.6 51.2 218.8
Strategic reorganization and other (benefits) charges (0.3) — 8.3 8.0
Total operating expenses 140.7 26.6 59.5 226.8
Operating income (loss) $ 204.3 $ (13.1) $ (59.5) 131.7
Pension benefit other than service (3.3)
Interest expense, net 23.4
Loss on early extinguishment of debt 16.7
Income before income taxes 94.9
Income tax expense 24.5
Net income $ 70.4
Year ended September 30, 2020
Infrastructure Technologies Corporate Total
(in millions)
Net sales $ 883.6 $ 80.5 $ — $ 964.1
Gross profit $ 315.7 $ 12.5 $ — $ 328.2
Operating expenses:
Selling, general and administrative
129.1 24.8 44.5 198.4
Strategic reorganization and other charges 0.6 0.1 12.3 13.0
Total operating expenses 129.7 24.9 56.8 211.4
Operating income (loss)
$ 186.0 $ (12.4) $ (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
Consolidated Analysis
Net sales for 2021 increased 15.2% to $1,111.0 million from $964.1 million in the prior year primarily as a result of higher shipment volume across most of our product lines and higher pricing. Additionally, net sales benefited as a result of $6.0 million of Krausz sales from the elimination of the one-month reporting lag.
Gross profit increased $30.3 million to $358.5 million for 2021 compared with $328.2 million in the prior year. This increase was primarily a result of increased shipment volume and higher pricing, partially offset by higher manufacturing costs as a result of inflation, higher labor costs, and a $2.4 million inventory write-off associated with the announcement of our plant closures in Aurora, Illinois and Surrey, British Columbia, Canada. Gross margin decreased to 32.3% in 2021 as compared with 34.0% in the prior year.
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Selling, general and administrative expenses (“SG&A”) increased 10.3% to $218.8 million for 2021 from $198.4 million in the prior year. As a percentage of net sales, SG&A decreased 90 basis points to 19.7% of net sales from 20.6% in the prior year. The increase in SG&A was primarily a result of increased personnel-related expenses, including incentive compensation, sales commissions associated with higher net sales and orders, and stock-based compensation. Additional increases were a result of inflation, new product development and information technology spending. Fiscal year 2020 SG&A included pandemic-driven benefits from temporarily reduced travel, trade show and event spending as well as temporary employee furloughs and temporary salary reductions.
Strategic reorganization and other charges for 2021 primarily relate to termination benefits associated with our plant closures in Aurora, Illinois and Surrey, British Columbia, Canada, the June 2021 mass shooting tragedy at our Albertville facility, and certain transaction-related costs, partially offset by a one-time settlement gain in connection with an indemnification of a previously owned property. In 2020, Strategic reorganization and other charges primarily relate to a legal settlement, facility closure costs, transaction costs associated with the acquisition of Krausz, and personnel matters.
Interest expense, net declined $2.1 million in 2021 from the prior year primarily as a result of the retirement of our 5.5% Senior Unsecured Notes (“5.5% Senior Notes”), which were replaced with 4.0% Senior Unsecured Notes (“4.0% Senior Notes”) as well as an increase in capitalized interest on our large capital projects, partially offset by lower interest income.
2021 2020
(in millions)
5.5% Senior Notes $ 17.6 $ 24.8
4.0% Senior Notes 6.2 —
Deferred financing costs amortization 1.1 1.2
ABL Agreement 0.9 0.6
Capitalized interest (2.3) (0.3)
Other interest expense 0.3 0.3
Total interest expense 23.8 26.6
Interest income (0.4) (1.1)
Total interest expense, net $ 23.4 $ 25.5
Income tax expense of $24.5 million in 2021 included an effective income tax rate of 25.8%, which was higher than the 23.5% rate in the prior year.
Segment Analysis
Infrastructure
Net sales for 2021 increased $138.4 million, or15.7%, to $1,022.0 million from $883.6 million in the prior year. Net sales increased primarily as a result of increased shipment volume, favorable pricing and $6.0 million in Krausz net sales as a result of the elimination of the one-month reporting lag. We believe the increased shipment volume was a result of strong demand driven by residential construction and municipal repair and replacement activity.
Gross profit for 2021 increased $29.3 million, or 9.3%, to $345.0 million from $315.7 million in the prior year primarily as a result of increased shipment volume, higher sales pricing and the benefit of the elimination of the Krausz one-month reporting lag. These increases were partially offset by higher material and other costs associated with inflation, specifically related to brass ingot, scrap steel and purchased parts, a $2.4 million inventory write-off associated with the announcement of the closure of our Aurora, Illinois and Surrey, British Columbia, Canada facilities and $2.9 million in expenses related to the pandemic, including voluntary emergency paid leave and other employee costs as well as additional sanitation and cleaning expenses. Gross margin was 33.8% in 2021, a 190 basis point decrease compared with 35.7% in the prior year.
SG&A in 2021 increased 9.2% to $141.0 million from $129.1 million in the prior year primarily as a result of increased personnel-related costs including higher sales commissions associated with higher net sales and orders, inflation, information technology spending, and new product development. Fiscal year 2020 SG&A included pandemic-driven benefits resulting from temporarily reduced travel, trade show and event spending as well as temporary employee furloughs and temporary salary reductions. SG&A was 13.8% and 14.6% of net sales for 2021 and 2020, respectively.
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Technologies
Net sales in 2021 increased to $89.0 million from $80.5 million in the prior year primarily as a result of higher shipment volumes and the acquisition of i2O.
Gross profit in 2021 increased $1.0 million to $13.5 million from $12.5 million in the prior year as a result of higher shipment volumes, partially offset by inflation and inventory adjustments. Gross margin decreased to 15.2% in 2021 from 15.5% in the prior year.
SG&A increased to $26.6 million in 2021 from $24.8 million in the prior year primarily as a result of personnel-related expenses. Fiscal year 2020 SG&A included pandemic-driven benefits resulting from temporarily reduced travel, trade show and event spending as well as temporary employee furloughs and temporary salary reductions. SG&A as a percentage of net sales was 29.9% for 2021 and 30.8% in the prior year.
Corporate
SG&A increased by $6.7 million from $44.5 million in 2020 to $51.2 million in 2021 as a result of increased personnel-related expenses and inflation. Fiscal year 2020 SG&A included pandemic-driven benefits resulting from temporary reductions in travel, trade show and event spending as well as temporary employee furloughs and temporary salary reductions.
Year Ended September 30, 2020 Compared to Year Ended September 30, 2019
Management’s Discussion and Analysis comparing the results for the year ended September 30, 2020 to the results for the year ended September 30, 2019 can be found in our Form 10-K for the year ended September 30, 2020.
Financial Condition
Cash and cash equivalents were $227.5 million at September 30, 2021 and $208.9 million at September 30, 2020. Cash and cash equivalents increased during 2021 as a result of $156.7 million in cash provided by operating activities, partially offset by capital expenditures of $62.7 million, dividend payments of $34.8 million, the $19.7 million acquisition of i2O, $12.4 million in debt repayments, net, and $10.0 million in share repurchases.
Receivables, net were $212.2 million at September 30, 2021 and $180.8 million at September 30, 2020. This increase was primarily a result of the increase in net sales year over year.
Inventories, net were $184.7 million at September 30, 2021 and $162.5 million at September 30, 2020. Inventories increased during 2021 as a result of increased volume and inflationary costs.
Property, plant and equipment, net was $283.4 million at September 30, 2021 and $253.8 million at September 30, 2020. Property, plant and equipment increased primarily as a result of our previously-announced capital expansion projects in Kimball, Tennessee and Decatur, Illinois. Capital expenditures, including software development costs capitalized and capitalized interest, were $62.7 million in 2021. Depreciation expense was $31.4 million in 2021 compared to $29.6 million in 2020 as a result of generally higher level of capital expenditures over the last three years.
Intangible assets were $392.5 million at September 30, 2021 and $408.9 million at September 30, 2020. Finite-lived intangible assets, net totaling $118.7 million at September 30, 2021, are amortized over their estimated useful lives. Amortization expense was $28.2 million in both 2021 and 2020. We expect amortization expense for these assets to range between approximately $27 million and $29 million in each of the next three years with a decrease to approximately $6 million in fiscal 2025 and approximately $5 million in fiscal 2026. Indefinite-lived intangible assets, $273.8 million at September 30, 2021, are not amortized but are tested for possible impairment at least annually.
Accounts payable and other current liabilities were $219.1 million at September 30, 2021 and $153.9 million at September 30, 2020. Payables increased during 2021 as a result of increased production volume and the impact of higher material costs. Other current liabilities increased during 2021 primarily as a result of personnel-related expenses, including incentive compensation and sales commissions, as well as customer rebates and income taxes.
Total outstanding debt was $446.9 million at September 30, 2021 and $447.6 million at September 30, 2020.
Deferred income taxes were net liabilities of $94.8 million at September 30, 2021 and $96.3 million at September 30, 2020, primarily related to intangible assets. The $1.5 million decrease in the net liability was primarily the result of an increase in deferred tax assets related to increased inventory reserves partially offset by an increase in deferred tax liabilities related to
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bonus depreciation for plant, property and equipment and the cost basis difference of a foreign subsidiary, net of reductions in deferred tax liabilities related to intangible assets.
Liquidity and Capital Resources
We had cash and cash equivalents of $227.5 million at September 30, 2021 and approximately $158.7 million of additional borrowing capacity under our ABL Agreement based on September 30, 2021 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, 2021, cash and cash equivalents included $39.2 million, $12.6 million, and $3.5 million in Israel, Canada and China, respectively.
Net cash provided by operating activities was $156.7 million for 2021 compared with $140.3 million for 2020 primarily as a result of the Walter tax matter which was paid in 2020 and did not recur in 2021.
Capital expenditures were $62.7 million for 2021 compared with $67.7 million for 2020. We estimate 2022 capital expenditures will be between $70 million and $80 million. We expect our capital expenditures will be elevated over the next several years as we invest more in our machinery, equipment and facilities for product introductions, enhanced productivity and maintenance. Additionally, in fiscal year 2021, we completed construction of our large casting foundry in Chattanooga, Tennessee, initiated 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, consolidate other plants and to insource various parts and components.
Income tax payments were higher during 2021 compared with the prior year primarily as a result of the Walter tax matter, which was expensed in 2019 and was deducted for tax purposes in 2020. This did not recur in 2021. We expect the effective tax rate in 2022 to be between 25% and 27%.
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 $250.0 million. We acquired 651,271 and 418,374 shares of our common stock in 2021 and 2020, respectively. At September 30, 2021, we had remaining authorization of $135.0 million to repurchase shares of our common stock.
We use letters of credit and surety bonds in the ordinary course of business to ensure the performance of contractual obligations. At September 30, 2021, we had $15.0 million of letters of credit and $36.7 million of surety bonds outstanding.
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, 2022. However, our ability to make these payments will depend largely on our future operating performance, which may be affected by general economic, financial, competitive, legislative, regulatory, business and other factors beyond our control.
ABL Agreement
At September 30, 2021, our asset-based lending agreement (“ABL Agreement”) consisted of a $175.0 million revolving credit facility that includes up to $25.0 million of swing line loans and allows for up to $60.0 million of letters of credit. The ABL Agreement permits us to increase the size of the credit facility by an additional $150.0 million in certain circumstances subject to adequate borrowing base availability.
Borrowings under the ABL Agreement bear interest at a floating rate equal to the London Inter Bank Offered Rate (“LIBOR”) plus an applicable margin of 200 to 225 basis points, or a base rate, as defined in the ABL Agreement, plus an applicable margin of 100 to 125 basis points. At September 30, 2021, the LIBOR-based applicable margin was 200 basis points.
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The 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 eligible inventory, less certain reserves. Prepayments can be made at any time without penalty.
Substantially all of our United States 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 United States inventory, accounts receivable, certain cash and other supporting obligations.
The ABL Agreement terminates on July 29, 2025 and includes an annual commitment fee for any unused borrowing capacity of 37.5 basis points. 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. Excess availability based on September 30, 2021 data was $158.7 million, as reduced by $15.0 million of outstanding letters of credit and $1.3 million of accrued fees and expenses.
4.0% Senior Unsecured Notes
On May 28, 2021, we privately issued $450.0 million of 4.0% Senior Unsecured Notes (“4.0% Senior Notes”), which mature in June 2029 and bear interest at 4.0%, paid semi-annually in June and December. We capitalized $5.5 million of financing costs, which are being amortized over the term of the 4.0% Senior Notes using the effective interest rate method. Proceeds from the 4.0% Senior Notes, along with cash on hand were used to redeem previously existing 5.5% Senior Notes. Substantially all of our United States subsidiaries guarantee the 4.0% Senior Notes, which are subordinate to borrowings under our ABL Agreement.
An indenture securing the 4.0% Senior Notes (“Indenture”) contains customary covenants and events of default, including covenants that limit our ability to incur certain debt and liens. There are no financial maintenance covenants associated with the Indenture. We believe we were in compliance with these covenants at September 30, 2021.
As set forth in the Indenture, we may redeem some or all of the 4.0% Senior Notes at any time prior to June 15, 2024 at certain “make-whole” redemption prices and on or after June 15, 2024 at specified redemption prices. Additionally, we may redeem up to 40% of the aggregate principal amount of the 4.0% Senior Notes at any time prior to June 15, 2024 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 would be required to offer to purchase the 4.0% Senior Notes at a price equal to 101% of the outstanding principal amount of the 4.0% Senior Notes.
5.5% Senior Unsecured Notes
On June 12, 2018, we privately issued $450.0 million of 5.5% Senior Unsecured Notes (“5.5% Senior Notes”), which were set to mature in 2026 and bore interest at 5.5%, paid semi-annually. We called the 5.5% Senior Notes effective June 17, 2021 and settled with proceeds from the issuance of the 4.0% Senior Notes and cash on hand. As a result, we incurred $16.7 million in loss on early extinguishment of debt, comprised of a $12.4 million call premium and a $4.3 million write-off of the remaining deferred debt issuance costs associated with the retirement of the 5.5% Senior 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,
2021 2020 2021 2020
Corporate credit rating Ba1 Ba2 BB BB
ABL Agreement Not rated Not rated Not rated Not rated
4.0% Senior Notes Ba1 N/A BB N/A
5.5% Senior Notes N/A Ba3 N/A BB
Outlook Stable Stable Stable Stable
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Effect of Inflation
We experience changing price levels primarily related to purchased components and raw materials. Infrastructure experienced a 33% increase in the average cost per ton of scrap steel and a 35% increase in the average cost of brass ingot in 2021 compared to 2020. Technologies was also unfavorably affected by the 35% increase in the average cost of brass ingot. We anticipate inflation in raw and other material costs in 2022, which may have an adverse effect on our margins to the extent we are unable to pass on such higher costs to our customers.
Material Cash Requirements
We enter into a variety of contractual obligations as part of our normal operations in addition to capital expenditures. As of September 30, 2021, we have (i) debt obligations related to our $450.0 million 4.0% Senior Notes which mature in 2029 and include cash interest payments of $18.9 million in 2022 and $18.0 million annually thereafter through 2029, (ii) operating and finance lease obligations that total $34.9 million in cash payments through 2033 and $2.3 million thereafter through 2026, respectively, and (iii) purchase obligations for raw materials and other parts within our Infrastructure segment of approximately $122.9 million which we will incur during 2022. We expect to fund these cash requirements from cash on hand and cash generated from operations.
Seasonality
Our water infrastructure business depends on construction activity. 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 Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States (“GAAP”) 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. Our critical accounting estimates include the below items.
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, net
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.
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
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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 Goodwill and Indefinite-lived 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, 2021, using standard valuation methodologies and rates that we considered reasonable and appropriate.
We evaluated goodwill for impairment using a quantitative analysis. We performed this annual impairment testing at September 1, and concluded that our goodwill was not impaired. This analysis is dependent on management’s best estimates of future operating results, including forecasted revenues, earnings before interest, taxes, depreciation and amortization (“EBITDA”) margins and the selection of reasonable discount rates. We also consider the guideline public company method when estimating the fair value of our reporting units. 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. We performed this annual impairment testing at September 1, and concluded that our indefinite-lived intangible assets were not impaired. Significantly different projected operating results could result in different conclusions regarding impairment.
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 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 in the normal course of 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 as a result of 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 17. of the Notes to Consolidated Financial Statements. See also “Item 1. BUSINESS - Regulatory and Environmental Matters,” “Item 1A. RISK FACTORS”.
Workers’ Compensation, Defined Benefit Pension Plans, Environmental and Other Long-term Liabilities
We are obligated for various liabilities that ultimately will be determined over what could be very long future time periods. We established the recorded liabilities for such items at September 30, 2021 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.