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”. This section of this Form 10-K generally discusses 2023 and 2022 items and year-to-year comparisons between 2023 and 2022. Discussion of year-to-year comparisons between 2022 and 2021 that are not included in this Form 10-K can be found in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7. of our Annual Report on Form 10-K for the year ended September 30, 2022.
Overview
Business
We adopted our current management structure effective October 1, 2021 which resulted in a change to our reportable segments. Under this structure, we operate our business through two segments, Water Flow Solutions and Water Management Solutions.
Effective August 21, 2023, the Company’s Chief Executive Officer (“CEO”) left his role and Marietta Edmunds Zakas, the Company’s Chief Financial Officer (“CFO”) was named President and CEO. Steven S. Heinrichs, the Company’s Chief Legal and Compliance Officer was named CFO and continues to serve as Chief Legal and Compliance Officer. In addition, certain other management changes occurred. As a result, the Company incurred transition and retention expense which has been recorded to Strategic reorganization and other charges in our consolidated statements of operations.
We estimate approximately 60% to 65% of the Company’s 2023 net sales were associated with repair and replacement of municipal water infrastructure, approximately 25% to 30% were related to residential construction activity and approximately 10% were related to natural gas utilities and industrial applications.
After experiencing challenges in 2020 and 2021 resulting from the pandemic, municipal spending on repair and replacement projects in 2023 and 2022 returned to more normalized levels. According to the United States Department of Labor, the trailing twelve-month average consumer price index for water and sewerage rates at September 30, 2023 increased 4.6%.
Recent Developments
In October 2023, the Israel-Hamas war caused a temporary shutdown in our facility in Ariel, Israel. While we have reopened the facility, the war increases the likelihood of supply interruptions and may hinder our ability to acquire the necessary materials we need to make our products. Supply disruptions from lack of access to materials has impacted, and continues to impact, our ability to produce and deliver our products on time and at favorable pricing from our facility in Ariel, Israel.
As announced on October 28, 2023, we identified a cybersecurity incident impacting certain internal operations and information technology systems. Based on the information reviewed to date, we believe the unauthorized activity has been contained. All of our facilities are operational and have substantially returned to normalized operations.
The cybersecurity incident consisted of unauthorized access and deployment of ransomware by a third party to a portion of our internal information infrastructure. The incident caused temporary disruptions and limitations of access to portions of our business applications supporting aspects of our operations and corporate functions, which limited our ability to take orders and ship products. Shipping delays and investigation and remediation costs in connection with the incident are expected to adversely impact our results for the first quarter of 2024, and such impact may be material. We have largely restored the impacted applications and systems, and we continue to execute business continuity and restoration plans for the remaining impacted applications and systems. As reported on November 29, 2023, we identified a separate cybersecurity incident, which primarily related to a system that was at the end of its useful life and was already in the process of being replaced in the ordinary course of business.
Our investigation and remediation efforts remain ongoing, including an analysis of data accessed, exfiltrated or otherwise impacted in connection with the cybersecurity incidents. We continue to evaluate the business, financial and related impacts of the cybersecurity incidents.
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Outlook
We expect the operating environment during fiscal 2024 to continue to be challenging as a result of high interest rates, the inflationary environment, labor challenges and a potential recession. We anticipate lower demand in the municipal repair and replacement end market due to budgetary pressures on municipalities resulting from high interest rates and inflation, especially for smaller municipalities. Demand from the new residential construction end market decreased in fiscal 2023 reflecting a 12.9% decrease in total housing starts as compared with fiscal 2022 according to Census data. For fiscal 2024, we anticipate that high interest rates will continue to impact housing starts and new lot and land development . In November 2023, Blue Chip Economic Indicators forecasted a 2.2% decrease in total housing starts for the calendar year 2024 compared to the calendar year 2023.
For our fiscal year 2024, we anticipate that consolidated net sales will be 3% to 8% lower than our fiscal year 2023 sales primarily driven by a decrease in volumes. In 2023, material costs rose as a result of an increase in purchased parts costs, primarily driven by higher freight, labor and energy costs. In 2024, we anticipate that inflation will continue in some areas leading to a modest increase in manufacturing costs. Additionally, as a result of the cybersecurity incident that occurred subsequent to the end of fiscal 2023, our 2024 operating results will be impacted by the expenses we have incurred and will continue to incur to investigate, assess, and remedy this incident. We currently are unable to estimate the impact that this will have on our financial results.
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Results of Operations
Year Ended September 30, 2023 Compared to Year Ended September 30, 2022
Year ended September 30, 2023
Water Flow
Solutions Water
Management
Solutions Corporate Consolidated
(in millions)
Net sales $ 634.4 $ 641.3 $ — $ 1,275.7
Gross profit 164.9 214.6 — 379.5
Operating expenses:
Selling, general and administrative
85.3 106.9 49.7 241.9
Strategic reorganization and other charges — 1.7 8.5 10.2
Total operating expenses 85.3 108.6 58.2 252.1
Operating income (loss) $ 79.6 $ 106.0 $ (58.2) 127.4
Pension expense other than service 3.7
Interest expense, net 14.7
Income before income taxes 109.0
Income tax expense 23.5
Net income $ 85.5
Year ended September 30, 2022
Water Flow
Solutions Water
Management
Solutions Corporate Consolidated
(in millions)
Net sales $ 714.1 $ 533.3 $ — $ 1,247.4
Gross profit 212.4 151.9 — 364.3
Operating expenses:
Selling, general and administrative
87.1 102.8 48.8 238.7
Strategic reorganization and other charges 0.2 0.4 6.6 7.2
Goodwill impairment 6.8 — — 6.8
Total operating expenses 94.1 103.2 55.4 252.7
Operating income (loss)
$ 118.3 $ 48.7 $ (55.4) 111.6
Pension benefit other than service (3.9)
Interest expense, net 16.9
Income before income taxes 98.6
Income tax expense 22.0
Net income $ 76.6
Consolidated Analysis
Net sales for 2023 increased $28.3 million, or 2.3%, to $1,275.7 million from $1,247.4 million in the prior year primarily as a result of higher pricing across most of our product lines partially offset by lower volumes at Water Flow Solutions.
Gross profit increased $15.2 million, or 4.2%, to $379.5 million for 2023 compared with $364.3 million in the prior year. This increase was primarily a result of higher pricing which was partially offset by lower volumes, unfavorable manufacturing performance, including labor and material inefficiencies and increased outsourcing, as well as inflation. Gross margin increased to 29.7% in 2023 as compared with 29.2% in the prior year.
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Selling, general and administrative expenses (“SG&A”) increased 1.3% to $241.9 million for 2023 from $238.7 million in the prior year. The increase in SG&A was primarily a result of higher costs associated with inflation, third-party fees, and insurance, partially offset by lower personnel-related and incentive costs. As a percentage of net sales, SG&A decreased 10 basis points to 19.0% of net sales from 19.1% in the prior year.
Strategic reorganization and other charges for 2023 of $10.2 million primarily consisted of expenses associated with the leadership transition and other restructuring charges related to severance in addition to certain transaction-related expenses. Strategic reorganization and other charges for 2022 of $7.2 million primarily consisted of certain transaction-related costs, expenses associated with our restructuring activities, and the Albertville tragedy.
During the year ended September 30, 2022, we incurred a non-cash goodwill impairment charge of $6.8 million within the Water Flow Solutions segment. No impairment charge was recorded in 2023.
Interest expense, net declined $2.2 million in 2023 from the prior year primarily as a result of higher interest income associated with higher interest rates. The components of net interest expense are provided below.
Year ended September 30,
2023 2022
(in millions)
4.0% Senior Notes $ 18.0 $ 18.0
Deferred financing costs amortization 1.0 1.0
ABL Agreement 0.9 0.9
Capitalized interest (1.6) (2.6)
Other interest expense 0.1 0.3
Total interest expense 18.4 17.6
Interest income (3.7) (0.7)
Total interest expense, net $ 14.7 $ 16.9
Income tax expense of $23.5 million in 2023 resulted in an effective income tax rate of 21.6%, which was lower than the 22.3% rate in the prior year reflecting benefits from research and development tax credits and lower effective state tax rates due to state apportionment changes.
Segment Analysis
Water Flow Solutions
Net sales for 2023 decreased $79.7 million, or 11.2%, to $634.4 million from $714.1 million in the prior year. Net sales decreased primarily as a result of lower volumes in iron gate valves and service brass products partially offset by higher pricing across most of Water Flow Solutions’ product lines.
Gross profit for 2023 decreased $47.5 million, or 22.4%, to $164.9 million from $212.4 million in the prior year primarily as a result of lower volumes, as well as unfavorable manufacturing performance and inflation partially offset by higher pricing across most product lines. Gross margin was 26.0% in 2023, as compared with 29.7% in the prior year.
SG&A in 2023 decreased 2.1% to $85.3 million from $87.1 million in the prior year primarily as a result of lower personnel and incentive related costs partially offset by higher costs associated with inflation, increased third-party fees, and higher insurance expense. SG&A as a percentage of net sales was 13.4% and 12.2% for 2023 and 2022, respectively.
During the year ended September 30, 2022, Water Flow Solutions incurred a non-cash goodwill impairment charge of $6.8 million. No impairment charge was recorded in 2023.
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Water Management Solutions
Net sales in 2023 increased $108.0 million, or 20.3%, to $641.3 million from $533.3 million in the prior year primarily as a result of higher pricing across most of Water Management Solutions’ product lines and increased volumes, particularly of fire hydrants due to an elevated backlog, as well as across most product lines.
Gross profit in 2023 increased $62.7 million or 41.3%, to $214.6 million from $151.9 million in the prior year. Gross margin increased to 33.5% in 2023 from 28.5% in the prior year primarily as a result of higher pricing and increased volumes across most product lines partially offset by unfavorable manufacturing performance and inflation.
SG&A increased 4.0% to $106.9 million in 2023 from $102.8 million in the prior year primarily as a result of higher costs associated with inflation, third-party fees, and new product development, partially offset by lower personnel-related and incentive costs. SG&A as a percentage of net sales was 16.7% for 2023 and 19.3% in the prior year.
Corporate
SG&A increased $0.9 million from $48.8 million in 2022 to $49.7 million in 2023 as a result of higher costs associated with inflation offset by lower personnel and incentive related costs.
Financial Condition
Cash and cash equivalents were $160.3 million at September 30, 2023 and $146.5 million at September 30, 2022. Cash and cash equivalents increased during 2023 as a result of $109.0 million in cash provided by operating activities, partially offset by capital expenditures of $47.6 million, dividend payments of $38.1 million, $10.0 million in common stock repurchases, and $4.3 million in effect of currency exchange rate changes on cash.
Receivables, net were $217.1 million at September 30, 2023 and $228.0 million at September 30, 2022. This decrease was primarily a result of lower sales in the final quarter of the year compared with the prior year.
Inventories, net were $297.9 million at September 30, 2023 and $278.7 million at September 30, 2022. Inventories increased during 2023 as a result of inflation and select inventory management to meet anticipated orders.
Property, plant and equipment, net was $311.7 million at September 30, 2023 and $301.6 million at September 30, 2022. Property, plant and equipment increased as a result of $47.6 million in capital expenditures primarily associated with our new foundry in Decatur, Illinois. Depreciation expense was $34.4 million in 2023 compared with $32.0 million in 2022 as a result of generally higher level of capital expenditures over the last two years.
Intangible assets were $334.0 million at September 30, 2023 and $361.2 million at September 30, 2022. Finite-lived intangible assets, net totaling $61.4 million at September 30, 2023, are amortized over their estimated useful lives. Amortization expense was $28.1 million in 2023 and $28.5 million in 2022. We expect amortization expense for these assets to be approximately $27 million for 2024, decreasing to approximately $7 million in fiscal 2025, approximately $6 million in fiscal 2026 and fiscal 2027, and approximately $5 million in fiscal 2028. Indefinite-lived intangible assets, $272.6 million at September 30, 2023, are not amortized but are tested for potential impairment at least annually.
Accounts payable and other current liabilities were $218.1 million at September 30, 2023 and $240.2 million at September 30, 2022. Accounts payable decreased during 2023 as a result of timing and a comparative reduction in the volume of inventory purchases. Other current liabilities decreased during 2023 primarily as a result of lower personnel-related expenses, including incentive compensation.
Total outstanding debt was $447.4 million as of September 30, 2023 and $446.9 million as of September 30, 2022. Total debt increased due to the amortization of deferred financing costs.
Deferred income taxes were net liabilities of $73.8 million at September 30, 2023 and $86.3 million at September 30, 2022, primarily related to intangible assets. The $12.5 million decrease in the net liability was primarily a result of an increase in deferred tax assets related to Internal Revenue Code Section 174 pertaining to the amortization of research and development expenditures which was first applicable to us beginning in our fiscal year 2023.
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Liquidity and Capital Resources
We had cash and cash equivalents of $160.3 million at September 30, 2023 and approximately $162.4 million of additional borrowing capacity under our asset-based lending arrangement (the “ABL”) based on September 30, 2023 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, 2023, cash and cash equivalents included $66.7 million, $8.7 million, and $10.9 million in Israel, Canada, and China, respectively.
We declared a quarterly dividend of $0.064 per common share on October 24, 2023, payable on or about November 20, 2023 to holders of record as of November 9, 2023, resulting in an estimated $10.0 million cash outlay.
We repurchased $10.0 million of our outstanding common stock during the fiscal year ended September 30, 2023 and had $90.0 million remaining under our share repurchase authorization as of September 30, 2023.
The ABL and 4.0% Senior Notes contain customary representations and warranties, covenants and provisions governing an event of default. The covenants restrict our ability to engage in certain activities including, but not limited to, the payment of dividends and the redemption of our common stock.
Collections from customers were higher during the fiscal year ended September 30, 2023 as compared with the prior year period primarily as a result of higher sales during the comparative periods. Inventories increased during the fiscal year ended September 30, 2023 as a result of timing and an increased volume of inventory purchases, partially offset by a decrease in inventory backlog. Other current liabilities and other noncurrent liabilities decreased as a result of employee incentive payouts, operating lease liabilities, and the repayment of the CARES Act employer payroll tax deferral, partially offset by an increase in the warranty accrual and returned goods refund liability.
Capital expenditures were $47.6 million for 2023 compared with $54.7 million for 2022. Capital expenditures decreased compared with the prior year period primarily as a result of lower expenditures associated with the new Decatur, Illinois foundry. We estimate 2024 capital expenditures will be between $45.0 million and $50.0 million.
Income tax payments were higher during 2023 compared with the prior year primarily as a result of higher income before income taxes as well as the timing of certain federal and state extension payments. We expect the effective tax rate in 2024 to be between 23% and 25%.
Our stock repurchase program allows us to repurchase up to $250.0 million of our common stock, of which we had remaining authorization of $90.0 million as of September 30, 2023. 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. We repurchased 714,830 and 2,654,254 shares of our common stock in 2023 and 2022, respectively.
We use letters of credit a nd surety bonds in the ordinary course of business to ensure the performance of contractual obligations. As of September 30, 2023, we had $12.4 million of letters of credit and $22.2 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, income tax payments, capital expenditures and debt service obligations as they become due through the twelve months from the date of this filing. 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
Our ABL, as amended, is provided by a consortium of banking institutions and consists of a revolving credit facility of $175.0 million in borrowing capacity that expires in July 29, 2025. Included in the ABL is the ability to borrow up to $25.0 million of swing line loans and up to $60.0 million of letters of credit. The ABL 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.
On April 5, 2023, we amended the ABL to replace LIBOR-based loans with Secured Overnight Financing Rate (“SOFR”) based loans plus an adjustment of 10 basis points, among other immaterial modifications.
Borrowings under the ABL bear interest at a floating rate equal to SOFR plus an adjustment of 10 basis points and an applicable margin range of 200 to 225 basis points, or a base rate, as defined in the ABL, plus an applicable margin of 100 to 125 basis points. At September 30, 2023, the applicable margin was 200 basis points for SOFR-based loans and 100 basis points for base rate loans.
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The ABL is subject to mandatory prepayments if total outstanding borrowings under the ABL 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 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 and are jointly and severally liable for any outstanding borrowings. Our obligations under the ABL are secured by a first-priority perfected lien on all of our United States inventory, accounts receivable, certain cash balances and other supporting obligations.
The ABL includes a commitment fee for any unused borrowing capacity of 37.5 basis points per annum. 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. Excess availability based on September 30, 2023 data was $162.4 million, as reduced by $12.4 million of outstanding letters of credit and $0.2 million of accrued fees and expenses.
In December 2023, we obtained a waiver under our ABL to provide us additional time to deliver to the ABL lenders certain information that was delayed as a result of the cybersecurity incident. The maximum aggregate of borrowings and other credit extensions under the ABL is limited to $50.0 million at any time outstanding until all of the delayed deliveries required under the ABL have been made.
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 on June 15, 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 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 U.S. subsidiaries guarantee the 4.0% Senior Notes, which are subordinate to borrowings under our ABL. Based on quoted market prices the outstanding 4.0% Senior Notes had a fair value of $393.7 million at September 30, 2023.
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. We believe we were in compliance with these covenants at September 30, 2023. There are no financial maintenance covenants associated with 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, 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,
2023 2022 2023 2022
Corporate credit rating Ba1 Ba1 BB BB
ABL Agreement Not rated Not rated Not rated Not rated
4.0% Senior Notes Ba1 Ba1 BB 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. During our fiscal year 2023, we experienced an 8% decrease in the average cost per ton of scrap steel and a 2% decrease in the average cost of brass as compared with our fiscal year 2022. We anticipate inflation in raw and other material costs in 2024, including on purchased components, which is likely to have an adverse effect on our margins to the extent we are unable to pass on such higher costs to our customers.
During fiscal year 2023, we experienced labor inflation of approximately 4.5%, consistent with the U.S. Bureau of Labor Statistics for the 12-month period ended September 30, 2023.
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, 2023, 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 $18.0 million in 2024 annually through 2029; (ii) cumulative cash obligations of $29.0 million for operating leases through 2033 and $1.4 million for finance leases through 2028; and (iii) purchase obligations for raw materials and other purchased parts of approximately $106.1 million and $1.4 million which we expect to incur during 2024 and 2025, respectively. Additionally, we will incur costs in 2024 to address and remediate the October 2023 cybersecurity incident, the extent of which is uncertain at this time. We expect to fund these cash requirements from cash on hand and cash generated from operations.
Seasonality
Our business is seasonal as a result of the impact of cold weather conditions. Net sales and operating income historically have been lowest in the three month periods ending December 31 and March 31 when the northern United States and most of Canada generally face weather conditions that restrict significant construction activity. For example, prior to the COVID-19 pandemic, net sales for the first half of the fiscal year averaged approximately 45% of consolidated net sales for the five-year period from 2015 to 2019. 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, sales, 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
For the majority of sales, we recognize revenue when control of promised products is transferred to our customers, in amounts that reflect the consideration to which we expect to be entitled in exchange for those products. 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
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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 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 deferred tax liabilities and assets 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 goodwill and indefinite-lived intangible assets for impairment annually or more frequently if events or circumstances indicate possible impairment. We perform this annual impairment testing on September 1, using standard valuation methodologies and rates that we considered reasonable and appropriate.
We evaluate goodwill for impairment using a quantitative analysis. The carrying value of the reporting unit, including goodwill, is compared with the estimated fair value of the reporting unit utilizing a combination of the income and market approaches. The income approach, which is a level 3 fair value measurement, is based on projected debt-free cash flow which is discounted to the present value using discount rates that consider the timing and risk of the cash flows. The market approach is based on the guideline public company method, which uses market multiples to value our reporting units. We weight the income and market approaches in a manner considering the risks of the underlying cash flows.
This income approach is dependent on management’s best estimates of future operating results, including forecasted sales, earnings before interest, taxes, depreciation and amortization (“EBITDA”) margins and the selection of discount rates. There are inherent uncertainties related to the assumptions used and to management's application of these assumptions.
We test our trade name 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 our annual impairment testing at September 1, 2023. The results of the testing indicated that the fair value exceeded the carrying value of our reporting units which contain goodwill. As such, no impairment charge was recorded. O ur determination of the estimated fair value was based on a combination of the discounted cash flow method and the guideline public company method. Additionally, w e performed our annual impairment testing of indefinite-lived intangible assets at September 1, 2023 and concluded no impairment losses should be recognized.
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Warranty Cost
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 to repair or replace 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.
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 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 15. 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, 2023 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, claim development, regulatory changes, technology changes, the investment performance of related assets, longevity of participants, the discount rate used and changes to plan designs.