Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis includes forward-looking statements about the Company’s business and consolidated results of operations for the fiscal years ended December 31, 2023 and 2022, including discussions about management’s expectations for the Company’s business. These statements represent projections, beliefs and expectations based on current circumstances and conditions and in light of recent events and trends, and these statements should not be construed either as assurances of performance or as promises of a given course of action. Instead, various known and unknown factors are likely to cause the Company’s actual performance and management’s actions to vary, and the results of these variances may be both material and adverse. A description of material factors known to the Company that may cause its results to vary, or may cause management to deviate from its current plans and expectations, is set forth under “Risk Factors” in this report. See also “Forward-Looking Statements.” The following discussion should also be read in conjunction with the Company’s consolidated financial statements and the related Notes included in this report.
Executive Overview
The Company designs, engineers, manufactures, markets and sells a broad range of advanced, emission-certified engines and power systems that run on a wide variety of clean, alternative fuels, including natural gas, propane, and biofuels, as well as gasoline and diesel options, within the power systems, industrial and transportation end markets with primary manufacturing, assembly, engineering, R&D, sales and distribution facilities located in suburban Chicago, Illinois and Darien and Beloit, Wisconsin. The Company provides highly engineered, comprehensive solutions designed to meet specific customer application requirements and technical specifications, including those imposed by environmental regulatory bodies, such as the EPA, the CARB and the MEE.
The Company’s products are primarily used by global OEM and end-user customers across a wide range of applications and equipment that includes standby and prime power generation, demand response, microgrid, combined heat and power, arbor care, material handling (including forklifts), agricultural and turf, construction, pumps and irrigation, compressors, utility vehicles, light- and medium-duty vocational trucks, school and transit buses, and utility power. The Company manages the business as a single reporting segment.
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Net sales by geographic area and by end market for 2023 and 2022 are presented below:
(in thousands) For the year ended December 31, 2023 For the Year Ended December 31, 2022
Geographic Area % of Total % of Total
United States $ 378,886 83 % $ 349,488 73 %
North America (outside of United States) 21,265 5 % 16,437 3 %
Pacific Rim 39,822 8 % 80,681 17 %
Europe 13,815 3 % 18,452 4 %
Others 5,185 1 % 16,275 3 %
Total $ 458,973 100 % $ 481,333 100 %
(in thousands) For the year ended December 31, 2023 For the Year Ended December 31, 2022
End Market % of Total % of Total
Power Systems $ 225,106 49 % $ 179,491 37 %
Industrial 160,334 35 % 224,669 47 %
Transportation 73,533 16 % 77,173 16 %
Total $ 458,973 100 % $ 481,333 100 %
During 2023, the Company sold over 33,500 engines of which approximately 76% utilized propane or natural gas as their fuel source and 17% utilized gasoline. The remaining 7% of engines were dual fuel gasoline/propane, diesel and service/base engines. During 2022 , the Company sold over 47,000 engines of which approximately 70% utilized propane or natural gas as their fuel source and 12% utilized gasoline. The remaining 18% of engines were dual fuel gasoline/propane, diesel and service/base engines.
Weichai Transactions
The Company sought to expand its range of products and its presence in the Pacific Rim through the Weichai Transactions (see Note 3. Weichai Transactions , included in Item 8. Financial Statements and Supplementary Data , for additional information).
The Company and Weichai executed the Collaboration Agreement in order to achieve their respective objectives, enhance the cooperation alliance and share experiences, expertise and resources. Among other things, the Collaboration Arrangement established a joint steering committee, permitted Weichai to second a limited number of technical, marketing, sales, procurement and finance personnel to work at the Company and established several collaborations related to stationary natural-gas applications and Weichai diesel engines. The Collaboration Agreement also provides for the steering committee to create various subcommittees with operating roles and otherwise governs the treatment of intellectual property of parties prior to the collaboration and the intellectual property developed during the collaboration. On March 22, 2023, the Collaboration Agreement was extended for an additional term of three years. The Company’s sales to Weichai were $1.7 million and $0.6 million during 2023 and 2022, respectively. The Company purchased $6.2 million and $13.3 million of inventory from Weichai during 2023 and 2022, respectively.
PSI also entered into a series of Shareholder Loan agreements with Weichai. See Note 6. Debt , included in Item 8. Financial Statements and Supplementary Data , for additional information.
Incremental Financial Reporting, Internal Control Remediation, and Government Investigation and Other Legal Matter Expenses
Incremental financial reporting, internal control remediation and government investigation and other legal matter expenses consist of professional services fees related to the Company’s efforts to restate prior period financial statements, prepare, audit and file delinquent financial statements, and remediate internal control material weaknesses as well as fees and reserves related to Company, SEC, and USAO investigations. Since August 2016, the Company has experienced a substantial and disruptive diversion of management resources to address various accounting, financial reporting and financial issues. During that time, the Company determined that it was necessary to restate financial results for 2014 and 2015 as well as the first quarter of 2016 and, since then, has also focused on becoming timely on all of its SEC financial reporting requirements, which was achieved with the filing of the Annual Report on Form 10-K for the year ended December 31, 2019. Additionally, the SEC and the USAO
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conducted investigations into the Company’s financial reporting, revenue recognition practices and related conduct. These investigations were completed and settled in September 2020 (see Note 10. Commitments and Contingencies , included in Part II. Item 8. Financial Statements and Supplementary Data , for additional information). Incremental financial reporting, internal control remediation, and government investigation and other legal matter expenses, included in the 2023 and 2022 operating results, were $0.2 million and $3.6 million, respectively.
Recent Trends and Business Outlook
As of the date of this 2023 Annual Report, the Company prudently continues to manage its expenses, including the restriction of all non-essential travel and minimized discretionary expenses and consulting services. The Company continues to review operating expenses, including prioritizing certain R&D investments in support of the Company’s long-term growth objectives. Starting in 2021 and throughout 2023, the Company took rightsizing actions to align its staffing with current needs, while also streamlining certain roles.
By the end of 2022, the global economy had mostly recovered after the global pandemic, COVID-19. The recovery led to challenging market conditions across certain areas of the Company’s business. Average crude oil prices reached the highest average price in five years in 2022 but has since declined while remaining near atop the 5-year averages through 2023. Rig counts in the U.S. oil markets also increased through 2022 but still under pre-pandemic levels as of the end of 2023. Despite increasing rig counts and crude oil prices, the Company believes that capital spending within the areas of the oil and gas market that it participates in, remains below pre-pandemic levels. While the Company saw an increase of sales to customers with traditional exposure to the oil and gas markets during 2023, as compared to the prior year, sales remain below pre-pandemic levels. A significant portion of the Company’s sales and profitability has historically been derived from the sale of products that are used within the oil and gas industry. The Company has seen logistical challenges experienced during prior years of port congestion and shipping delays ease and return to a pre-pandemic state and, excluding any unforeseen events, expects this to continue. However, the Company continues to experience inflationary cost pressures for certain raw materials and other goods which the Company continues to try to mitigate through price increases and other cost reduction measures. Additionally, the Company continues to experience ongoing tariff costs for products and is trying to mitigate these impacts through price increases and other measures, such as seeking certain tariff exclusions, where possible. The potential for continued economic uncertainty and unfavorable oil and gas market dynamics may have a material adverse impact on the levels of future customer orders and the Company’s future business operations, financial condition and liquidity.
In June 2022 , the SEC matter concerning former officers and employees was settled. As a result, the Company’s potential future costs for indemnity obligations related to this matter significantly decreased in 2023. Meanwhile, the Company continues to be party to several legal contingencies. Se e Note 10. Commitments and Contingencies for further discussion of the Company’s indemnification obligations.
The Company expects its sales in 2024 to increase by approximately 3% compared to 2023 levels, as a result of expectations for strong growth in the power systems end market paired with flat sales in the industrial end market and a forecasted reduction in the transportation end markets. Notwithstanding this outlook, which is being driven in part by expectations for stable supply chain dynamics and a continuation of favorable economic conditions within the United States and across the Company’s various markets, the Company cautions that significant uncertainty remains as a result of supply chain challenges, inflationary costs, commodity volatility, and rising interest rates among other factors.
Hyster-Yale Supply Arrangemen t : Hyster-Yale started sourcing alternative supply beginning in late 2023 for several high-volume engines that the Company currently provides, including the 2.0L and 2.4L engines which was accelerated in part due to supply chain issues from the UFLPA enforcement at the end of 2023. As a result, the Company expects to see a decline in sales volumes to Hyster-Yale in 2024 but believes it is well positioned to continue its relationship in a moderated capacity with this customer in 2024 and beyond.
Strategic Initiatives/Growth Strategies : The Company has initiated various business objectives aimed at improving profitability, streamlining processes, strengthening the business and focusing on achieving growth in higher-return product lines. Central to this plan is the Company’s increased emphasis on power systems product offerings through new product development and investments, in addition to leveraging the Company’s relationship with Weichai. With the introduction of numerous natural gas and diesel engines over the past few years, coupled with its existing strong product lineup, the Company believes that it has a solid foundation to achieve long-term growth, particularly within the power systems market.
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Results of Operations
Results of operations for the year ended December 31, 2023 compared with the year ended December 31, 2022 :
(in thousands, except per share amounts) For the Year Ended December 31,
2023 2022 Change % Change
Net sales
(from related parties $2,449 and $2,749 for the year ended December 31, 2023 and 2022, respectively)
$ 458,973 $ 481,333 $ (22,360) (5) %
Cost of sales
(from related parties $1,790 and $2,262 for the year ended December 31, 2023 and 2022, respectively)
353,109 392,770 (39,661) (10) %
Gross profit 105,864 88,563 17,301 20 %
Gross margin % 23.1 % 18.4 % 4.7 %
Operating expenses:
Research and development expenses 19,457 18,896 561 3 %
Research and development expenses as a % of sales 4.2 % 3.9 % 0.3 %
Selling, general and administrative expenses 40,386 42,941 (2,555) (6) %
Selling, general and administrative expenses as a % of sales 8.8 % 8.9 % (0.1) %
Amortization of intangible assets 1,746 2,124 (378) (18) %
Total operating expenses 61,589 63,961 (2,372) (4) %
Operating income 44,275 24,602 19,673 80 %
Interest expense (from related parties $7,729 and $4,680 for the year ended December 31, 2023 and 2022, respectively)
17,069 13,028 4,041 31 %
Income before income taxes 27,206 11,574 15,632 135 %
Income tax expense 900 304 596 NM
Net income $ 26,306 $ 11,270 $ 15,036 133 %
Earnings per common share:
Basic $ 1.15 $ 0.49 $ 0.66 135 %
Diluted $ 1.15 $ 0.49 $ 0.66 135 %
Non-GAAP Financial Measures:
Adjusted net income * $ 26,552 $ 15,735 $ 10,817 69 %
Adjusted income per share * $ 1.17 $ 0.69 $ 0.48 70 %
EBITDA * $ 49,875 $ 31,292 $ 18,583 59 %
Adjusted EBITDA * $ 50,121 $ 35,757 $ 14,364 40 %
NM Not meaningful
* See reconciliation of non-GAAP financial measures to GAAP results below
Net Sales
Net sales decreased $22.4 million, or 5%, compared to 2022, as a result of sales decreases of $64.3 million and $3.6 million within the industrial and transportation end markets, respectively, partly offset by an increase of $45.6 million in the power systems end market. Decreased industrial end market sales are primarily due to decreases in demand for products used within the material handling and arbor care market s as well as being directly affected by the enforcement of the UFLPA which limited the Company’s ability to import certain raw materials at the end of 2023. The decreased sales within the transportation end market were primarily attributable to lower sales in the school bus market as customer products have evolved and new compliance and regulatory requirements have changed engine product offerings . Higher power systems end market sales are primarily due to increased demand for products across various applications, with the largest increases attributable to products used within the demand response market as well as traditional oil and gas products.
Gross Profit
Gross profit increased by $17.3 million, or 20%, to $105.9 million in 2023, compared to $88.6 million in 2022. Gross margin was 23.1% and 18.4% in 2023 and 2022, respectively. The increase in gross margin is primarily due to improved mix, pricing actions and freight cost management. For the year ended December 31, 2023, warranty costs were $13.0 million, an increase of
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$6.6 million compared to warranty costs of $6.4 million in the same period last year, mainly attributable to changes in estimates for preexisting warranties. A majority of the warranty activity is attributable to products sold within the transportation end market in prior years.
Research and Development Expenses
R&D expenses in 2023 were $19.5 million, an increase of $0.6 million, or 3%, from 2022 levels as a result of the Company’s continued efforts to customize power systems to meet customers’ needs and meet emission and other certificate requirements.
Selling, General and Administrative Expenses
Selling, general and administrative (“SG&A”) decreased in 2023 by $2.6 million, or 6%, compared to 2022. The decrease is primarily due to lower legal costs during the period. These decreased costs were partially offset by an increase in incentive compensation expense.
Interest Expense
Interest expense increased $4.0 million to $17.1 million in 2023 from $13.0 million in 2022 , largely due to lower average outstanding debt, partially offset by higher overall effective interest rates on the Company’s debt. See Note 6. Debt , included in Item 8. Financial Statements and Supplementary Data for additional information.
Income Tax Expense
The Company recorded income tax expense of $0.9 million in 2023, an increase of $0.6 million, as compared to an income tax expense of $0.3 million in 2022. The Company’s pretax income was $27.2 million in 2023, compared to pretax income of $11.6 million in 2022. Income tax expense for the year ended December 31, 2023 is related primarily to the impact of amended state returns, adjustments to taxes payable, and deferred tax liability related to indefinite lived assets. The Company continues to record a full valuation allowance against deferred tax assets which offsets the tax expense and tax benefit associated with the pre-tax income and pre-tax loss for both years ended December 31, 2023 and 2022.
See Note 11. Income Taxes , included in Item 8. Financial Statements and Supplementary Data , for additional information related to the Company’s income tax provision.
Non-GAAP Financial Measures
In addition to the results provided in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) above, this report also includes non-GAAP (adjusted) financial measures. Non-GAAP financial measures provide insight into selected financial information and should be evaluated in the context in which they are presented. These non-GAAP financial measures have limitations as analytical tools and should not be considered in isolation from, or as a substitute for, financial information presented in compliance with U.S. GAAP, and non-GAAP financial measures as reported by the Company may not be comparable to similarly titled measures reported by other companies. The non-GAAP financial measures should be considered in conjunction with the consolidated financial statements, including the related notes, and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this report. Management does not use these non-GAAP financial measures for any purpose other than the reasons stated below.
Non-GAAP Financial Measure Comparable GAAP Financial Measure
Adjusted net income Net income
Adjusted net income per share Net income per common share – diluted
EBITDA Net income
Adjusted EBITDA Net income
The Company believes that Adjusted net income, Adjusted net income per share, EBITDA, and Adjusted EBITDA provide relevant and useful information, which is widely used by analysts, investors and competitors in its industry as well as by the Company’s management in assessing the performance of the Company. Adjusted net income is defined as net income as adjusted for certain items that the Company believes are not indicative of its ongoing operating performance. Adjusted net income per share is a measure of the Company’s diluted net earnings per share adjusted for the impact of special items. EBITDA provides the Company with an understanding of earnings before the impact of investing and financing charges and income taxes. Adjusted EBITDA further excludes the effects of other non-cash and certain other items that do not reflect the ordinary earnings of the Company’s operations.
Adjusted net income, Adjusted net income per share, EBITDA, and Adjusted EBITDA are used by management for various purposes, including as a measure of performance of the Company’s operations and as a basis for strategic planning and forecasting. Adjusted net income, Adjusted net income per share, and Adjusted EBITDA may be useful to an investor because these measures are widely used to evaluate companies’ operating performance without regard to items excluded from the
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calculation of such measures, which can vary substantially from company to company depending on the accounting methods, the book value of assets, the capital structure and the method by which the assets were acquired, among other factors. They are not, however, intended as an alternative measure of operating results or cash flow from operations as determined in accordance with U.S. GAAP.
The following table presents a reconciliation from Net income to Adjusted net income:
(in thousands) For the Year Ended December 31,
2023 2022
Net income $ 26,306 $ 11,270
Stock-based compensation 1
151 385
Severance 2
— 462
Internal control remediation 3
— 467
Governmental investigations and other legal matters 4
195 3,151
Insurance proceeds 5
(100) —
Adjusted net income $ 26,552 $ 15,735
The following table presents a reconciliation from Net income per common share – diluted to Adjusted net income per share – diluted:
For the Year Ended December 31,
2023 2022
Net income per common share – diluted $ 1.15 $ 0.49
Stock-based compensation 1
0.01 0.02
Severance 2
— 0.02
Internal control remediation 3
— 0.02
Governmental investigations and other legal matters 4
0.01 0.14
Adjusted net income per share – diluted $ 1.17 $ 0.69
Diluted shares (in thousands) 22,973 22,948
The following table presents a reconciliation from Net income to EBITDA and Adjusted EBITDA:
(in thousands) For the Year Ended December 31,
2023 2022
Net income $ 26,306 $ 11,270
Interest expense 17,069 13,028
Income tax expense 900 304
Depreciation 3,854 4,566
Amortization of intangible assets 1,746 2,124
EBITDA 49,875 31,292
Stock-based compensation 1
151 385
Severance 2
— 462
Internal control remediation 3
— 467
Governmental investigations and other legal matters 4
195 3,151
Insurance proceeds 5
(100) —
Adjusted EBITDA $ 50,121 $ 35,757
1. Amounts reflect non-cash stock-based compensation expense.
2. Amounts represent severance and other post-employment costs for certain former employees of the Company.
3. Amounts represent professional services fees related to the Company’s efforts to remediate internal control material weaknesses including certain costs to upgrade IT systems.
4. Amounts include professional services fees and reserves related to legal matters.
5. Amounts include insurance recoveries related to a prior year incident and have no material impact on the Adjusted earnings per share for the year ended December 31, 2023 and 2022.
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Cash Flows
Cash was impacted as follows:
(in thousands) For the Year Ended
December 31,
2023 2022 Change % Change
Net cash provided by (used in) operating activities $ 70,512 $ (8,845) $ 79,357 NM
Net cash used in investing activities (5,020) (1,354) (3,666) NM
Net cash (used in) provided by financing activities (66,798) 28,367 (95,165) NM
Net (decrease) increase in cash, cash equivalents, and restricted cash $ (1,306) $ 18,168 $ (19,474) (107) %
Capital expenditures $ (5,036) $ (1,354) $ (3,682) NM
NM Not meaningful
Cash Flow from Operating Activities
Net cash provided by operations was $70.5 million in 2023 compared to net cash used in operations of $8.8 million in 2022 resulting in an increase of $79.4 million in cash provided by operating activities year-over-year . The increase in cash provided by operating activities primarily resulted from the $15.0 million increase in earnings, reduction in inventory, increased collections on customer accounts receivable and the Company had less cash paid against accounts payable compared to the prior year due to a catch up on payables in the first nine months of 2022, contributing to a $64.9 million increase of cash provided by working capital accounts.
Cash Flow from Investing Activities
Net cash used in investing activities was $5.0 million for the year ended December 31, 2023 compared to cash used in investing activities of $1.4 million for year ended December 31, 2022, respectively . For the years ended December 31, 2023 and 2022, cash used in investing activities primarily related to capital expenditures associated with normal maintenance of the Company’s facilities.
Cash Flow from Financing Activities
The Company used $66.8 million in cash from financing activities in the year ended December 31, 2023 compared to $28.4 million in cash generated by financing activities in the year ended December 31, 2022. The cash used by financing activities for the year ended December 31, 2023, was a result of repayment of existing debt during the year. Whereas, cash provided in 2022 was primarily attributable to cash received under the shareholder’s loan agreements with Weichai. Se e additional discussion below and in Note 6. Debt in Item 8. Financial Statements and Supplementary Data related to the amendments of the Company’s debt arrangements .
Liquidity and Capital Resources
The Company’s sources of funds are cash flows from operations, borrowings made pursuant to our credit facilities, shareholder’s loan agreements, and cash and cash equivalents on hand. Principal uses of funds consist of payments of principal interest on our debt facilities and shareholder’s loan agreements, capital expenditures, and working capital needs.
As of December 31, 2023 , the Company’s total outstanding debt obligations under the Credit Agreement , the second Amended Shareholder’s Loan Agreement, the third Amended Shareholder’s Loan Agreement , the fourth Amended Shareholder’s Loan Agreement and for finance leases and other debt were $145.2 million in the aggregate, and its cash and cash equivalents were $22.8 million. See Item 8. Financial Statements and Supplementary Data , Note 6. Debt, for additional information.
Significant uncertainties exist about the Company’s ability to refinance, extend, or repay its outstanding indebtedness under its existing debt arrangements, maintain sufficient liquidity to fund its business activities, and maintain compliance with the covenants and other requirements under the Credit Agreement or shareholder’s loan agreements in the future. Without additional financing, the Company anticipates that it will not have sufficient cash and cash equivalents to repay the outstanding indebtedness under the Company’s existing debt arrangements as they become due. Management currently plans to seek an extension and/or replacement of its existing debt arrangements or seek additional liquidity from its current or other lenders before the maturity dates in 2024. There can be no assurance that the Company will be able to successfully complete a refinancing on acceptable terms or repay this outstanding indebtedness when required or if at all.
By the end of 2022, the global economy had mostly recovered after the global pandemic, COVID-19. The recovery led to challenging market conditions across certain areas of the Company’s business. Average crude oil prices reached the highest average price in five years in 2022 but has since declined while remaining near atop the 5-year averages through 2023. Rig counts in the U.S. oil markets also increased through 2022 but still under pre-pandemic levels as of the end of 2023. Despite increasing rig counts and crude oil prices, the Company believes that capital spending within the areas of the oil and gas market
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that it participates in, remains below pre-pandemic levels. While the Company saw an increase of sales to customers with traditional exposure to the oil and gas markets during 2023, as compared to the prior year, sales remain below pre-pandemic levels. A significant portion of the Company’s sales and profitability has historically been derived from the sale of products that are used within the oil and gas industry. The Company has seen logistical challenges experienced during prior years of port congestion and shipping delays ease and return to a pre-pandemic state and, excluding any unforeseen events, expects this to continue. However, the Company continues to experience inflationary cost pressures for certain raw materials and other goods which the Company continues to try to mitigate through price increases and other cost reduction measures. Additionally, the Company continues to experience ongoing tariff costs for products and is trying to mitigate these impacts through price increases and other measures, such as seeking certain tariff exclusions, where possible. The potential for continued economic uncertainty and unfavorable oil and gas market dynamics may have a material adverse impact on the levels of future customer orders and the Company’s future business operations, financial condition and liquidity.
Lastly, national inflationary pressures have continued to cause interest rates to remain at elevated levels. As a result, the Company’s interest expense has increased and is subject to further increases. Accordingly, the above challenges may continue to have a material adverse impact on the Company’s future results of operations, financial position, and liquidity.
Due to uncertainties surrounding the Company’s future ability to refinance, extend, or repay its outstanding indebtedness under its existing debt arrangements, maintain sufficient liquidity to fund its business activities, and maintain compliance with the covenants and other requirements under the Credit Agreement or shareholder’s loan agreements in the future, substantial doubt exists as to its ability to continue as a going concern within one year after the date that these financial statements are issued. If the Company does not have sufficient liquidity to fund its business activities, it may be forced to limit its business activities or be unable to continue as a going concern, which would have a material adverse effect on its results of operations and financial condition.
At December 31, 2023, the Company had four outstanding letters of credit totaling $1.9 million. See Item 8. Financial Statements and Supplementary Data, Note 10. Commitments and Contingencies for additional information related to the Company’s off-balance sheet arrangements and the outstanding letters of credit.
Commitments and Contingencies
Legal matters are further discussed in Note 10. Commitments and Contingencies , included in Item 8. Financial Statements and Supplementary Data . See Part I. Item 1A. Risk Factors for further discussion of legal risks to the Company.
Critical Accounting Policies and Estimates
The Company’s consolidated financial statements are prepared in accordance with U.S. GAAP. Preparation of these financial statements requires the Company to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company’s most critical accounting policies and estimates are those most important to the portrayal of its financial condition and results of operations which require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. The Company has identified the following as its most critical accounting policies and judgments. Although management believes that its estimates and assumptions are reasonable, they are based on information available when they are made and, therefore, may differ from estimates made under different assumptions or conditions.
The Company’s significant accounting policies are discussed in Note 1. Summary of Significant Accounting Policies and Other Information , included in Item 8. Financial Statements and Supplementary Data , and should be reviewed in connection with the following discussion of accounting policies that require difficult, subjective, and complex judgments and estimates.
Revenue Recognition
Revenue for the Company is generated from contracts when performance obligations under terms of the contract with a customer are satisfied, which is generally when control of the product has been transferred to the customer. For contracts with customers that include multiple performance obligations, judgment is required to determine whether performance obligations specified in these contracts are distinct and should be accounted for as separate revenue transactions for recognition purposes. For the majority of the Company’s products, revenue is recognized when the products are shipped or delivered to the customer based on the shipping terms which is usually when control passes to the customer. Conversely, the Company recognizes revenue throughout the manufacturing process when constructing because the customer receives the benefit of the asset as the product is constructed. The Company recognizes revenue related to extended warranty programs based on the passage of time over the extended warranty period.
The Company allows product returns on certain products. The accrued sales returns in the accompanying Consolidated Balance Sheet, included in Accounts Receivable, net, were $0.1 million and $0.3 million as of December 31, 2023 and 2022, respectively. Estimated sales returns are provided at the time of sale based on historical sales channel return rates. Estimated future obligations related to these products are provided by a reduction of sales in the period in which the revenue is recognized.
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We considered the impact of recoverable salvage value on sales returns by product in determining its estimate of future sales returns. We recognize a return asset for the right to recover the goods returned by the customer. The right of return asset is recognized on a gross basis outside of the accrued sales returns and is not material to our Consolidated Balance Sheets. In the event future sales returns claims are higher than our historical experiences, such as a 50 basis point increase, the impacts would not be material to the Consolidated Financial Statements.
The allowance for credit losses is our best estimate of the amount of estimated lifetime credit losses in our accounts receivable. We regularly review the adequacy of our allowance for credit losses.
The credit environment in which our customers operate has been relatively stable over the past few years and the Company collections are bolstered by a robust collections department. Historically, less than 1.0% of net sales ultimately prove to be uncollectible. Total bad debt expense was less than $0.1 million in both 2023 and 2022. If circumstances change, for example, due to the occurrence of higher-than-expected defaults or a significant adverse change in a major customer’s ability to meet our financial obligations such as bankruptcies, estimates of the recoverability of receivable amounts due could be reduced.
We have not made any material changes in the accounting methodology we use to measure the estimated liability for sales returns or allowance for credit losses during the past three fiscal years.
Refer to Note 2. Revenue of the notes to the consolidated financial statements for more information on the Company’s revenue recognition.
Goodwill Impairment
Goodwill and indefinite-lived intangible assets are evaluated for impairment annually as of October 1 and whenever events or circumstances make it more likely than not that impairment may have occurred or when required by accounting standards. We test goodwill and individual indefinite-lived intangible assets for impairment at a single reporting unit level. These assessments may be performed quantitatively or qualitatively.
We have not made any changes in 2023 to our reporting unit or the accounting methodology we use to assess impairment loss on goodwill and indefinite-lived intangible assets. In 2023, management performed an assessment of the impairment of goodwill for our reporting unit and indefinite-lived intangible assets using a quantitative approach, which indicated that the fair values the reporting unit and indefinite-lived intangible assets were substantially in excess of their carrying values. Therefore, no indications of impairment were identified.
Because these estimates form a basis for the determination of whether the impairment charge should be recorded, these estimates are considered to be critical accounting estimates. S ee Note 1. Summary of Significant Accounting Policies and Other Information , included in Item 8. Financial Statements and Supplementary Data for further discussion.
Warranty
The Company offers a standard limited warranty on the workmanship of its products that in most cases covers defects for a defined period, warranties mandated by governments and warranties for products that carry limited warranties from suppliers. The Company estimates and records a liability and related charges to income for its warranty program at the time products are sold to customers. Estimates are based on historical experience and reflect management’s best estimates of expected costs at the time products are sold.
When the Company identifies cost effective opportunities to address issues in products sold or corrective actions for safety issues, it initiates product recalls or field campaigns. As a result of the uncertainty surrounding the nature and frequency of product recalls and field campaigns, the liability for such actions is generally recorded when the Company commits to a product recall or field campaign. When collection is reasonably assured, the Company also estimates the amount of warranty claim recoveries to be received from its suppliers. Warranty costs and recoveries are included in Cost of sales in the Consolidated Statements of Income. Warranty costs and recoveries are included in Cost of sales in the Consolidated Statements of Income. S ee Note 1. Summary of Significant Accounting Policies and Other Information , included in Item 8. Financial Statements and Supplementary Data for further discussion.
Impact of New Accounting Standards
For information about recently issued accounting pronouncements, see Note 1. Summary of Significant Accounting Policies and Other Information , included in Item 8. Financial Statements and Supplementary Data .
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
The Company is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide the information under this item.
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