WINNEBAGO INDUSTRIES INC (WGO) FY 2024 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results. Unless otherwise noted, transactions and other factors significantly impacting our financial condition, results of operations and liquidity are discussed in order of magnitude. Our MD&A is presented in five sections:
•Overview
•Results of Operations
•Analysis of Financial Condition, Liquidity, and Capital Resources
•Critical Accounting Policies and Estimates
•New Accounting Pronouncements
Our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 8 of Part II in this Annual Report on Form 10-K.
The year-over-year comparisons in this MD&A are as of and for the fiscal years ended August 31, 2024 and August 26, 2023, unless stated otherwise. The discussion of Fiscal 2022 results and related year-over-year comparisons as of and for the fiscal years ended August 26, 2023 and August 27, 2022 are found in Item 7 of Part II of our Form 10-K for the fiscal year ended August 26, 2023.
Overview
Winnebago Industries, Inc. is one of the leading North American manufacturers of recreation vehicles ("RVs") and marine products with a diversified portfolio used primarily in leisure travel and outdoor recreational activities. We also design and manufacture advanced battery solutions that deliver “house power,” supporting internal electrical features and appliances for a variety of outdoor products including RVs, boats, specialty and other low-speed vehicles, as well as other industrial applications. Other products manufactured by us consist primarily of original equipment manufacturing parts for other manufacturers and commercial vehicles. We produce our motorhome RV units in Iowa and Indiana; our towable RV units in Indiana; our marine units in Indiana and Florida; and our battery solutions in Florida. We distribute our RV and marine products primarily through independent dealers across the U.S. and Canada, who then retail the products to the end consumer. We also distribute our marine products internationally through independent dealers, who then retail the products to the end consumer. Our battery solutions are primarily sold to customers in the U.S.
Known Trends and Uncertainties
Our business continues to be challenged by macroeconomic conditions impacting retail consumers and our dealers, such as inflation and elevated interest rates. These factors have contributed to lower consumer spending and reduced short-term demand for large discretionary products such as RVs and marine products. In response, our dealers continue to exercise caution when managing stocking levels. In Fiscal 2024, these trends resulted in decreased sales due to declines in unit volume. We anticipate that as consumer demand stabilizes, dealers will exhibit a willingness to maintain stable inventory levels and ordering patterns. We continue to produce and ship in accordance with dealer demand as evidenced and requested by dealer orders.
Despite the current economic uncertainty, we believe in the long-term health of consumer demand for RV and marine products.
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Other Matters
During the fourth quarter of Fiscal 2024, we recognized a $30.3 million impairment charge equal to the full carrying value of goodwill associated with the Chris-Craft reporting unit. The decline in fair value of the Chris-Craft reporting unit was driven primarily by a downward revision to forecasted cash flows made during the fourth quarter of Fiscal 2024 as part of our annual long range planning process, and a decline in market capitalization observed from guideline public companies. Projected future cash flows for the Chris-Craft reporting unit have declined compared to prior expectations as a result of sustained macroeconomic challenges impacting consumer demand, such as inflationary pressures and elevated interest rates, and the current uncertainty regarding timing and degree of economic recovery. Refer to Note 7 in the Notes to Consolidated Financial Statements, included in Item 8 of Part II in this Annual Report on Form 10-K for more information.
During the second quarter of Fiscal 2024, we entered into separate, privately negotiated transactions with certain holders of the 2025 Convertible Notes to repurchase $240.7 million aggregate principal amount of the 2025 Convertible Notes using $293.8 million of the net proceeds received from the issuance of the 2030 Convertible Notes. In connection with the 2025 Convertible Note repurchases, we recorded a loss on note repurchase of $32.7 million in the accompanying Consolidated Statements of Income during Fiscal 2024. The loss on note repurchase represents the difference between the fair value of consideration transferred to the holders of the repurchased 2025 Convertible Notes and the conversion value of 2025 Convertible Notes repurchased pursuant to the original conversion terms. Refer to Note 9 in the Notes to Consolidated Financial Statements, included in Item 8 of Part II in this Annual Report on Form 10-K for more information.
Non-GAAP Financial Measures
This MD&A includes financial information prepared in accordance with generally accepted accounting principles ("GAAP"), as well as certain adjusted or non-GAAP financial measures, such as EBITDA and Adjusted EBITDA. EBITDA is defined as net income before interest expense, provision for income taxes, and depreciation and amortization expense. Adjusted EBITDA is defined as net income before interest expense, provision for income taxes, depreciation and amortization expense, and other pretax adjustments made in order to present comparable results from period to period.
These non-GAAP financial measures, which are not calculated or presented in accordance with GAAP, have been provided as information supplemental and in addition to the financial measures presented in accordance with GAAP. Such non-GAAP financial measures should not be considered superior to, as a substitute for, or as an alternative to, and should be considered in conjunction with, the GAAP financial measures presented herein. The non-GAAP financial measures presented may differ from similar measures used by other companies.
Included in "Results of Operations - Fiscal 2024 Compared to Fiscal 2023" is a reconciliation of EBITDA and Adjusted EBITDA from net income, the most directly comparable GAAP measure. We have included these non-GAAP performance measures as a comparable measure to illustrate the effect of non-recurring transactions that occurred during the reported periods and to improve comparability of our results from period to period. We believe Adjusted EBITDA provides meaningful supplemental information about our operating performance as this measure excludes amounts from net income that we do not consider part of our core operating results when assessing our performance. Examples of items excluded from Adjusted EBITDA include acquisition-related costs, litigation reserves, change in fair value of note receivable and other investments, contingent consideration fair value adjustment, goodwill impairment, loss on note repurchase, and non-operating income or loss.
Management uses these non-GAAP financial measures (a) to evaluate our historical and prospective financial performance and trends as well as our performance relative to competitors and peers; (b) to measure operational profitability on a consistent basis; (c) in presentations to the members of our Board of Directors to enable our Board of Directors to have the same measurement basis of operating performance as used by management in its assessments of performance and in forecasting; (d) to evaluate potential acquisitions; and (e) to ensure compliance with covenants and restricted activities under the terms of our ABL Credit Facility and outstanding notes, as further described in Note 9 in the Notes to Consolidated Financial Statements, included in Item 8 of Part II in this Annual Report on Form 10-K. We believe these non-GAAP financial measures are frequently used by securities analysts, investors and other interested parties to evaluate companies in the industry.
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Results of Operations - Fiscal 2024 Compared to Fiscal 2023
Consolidated Performance Summary
The following is an analysis of changes in key items included in the statements of operations for the fiscal year ended August 31, 2024 compared to the fiscal year ended August 26, 2023:
| (in millions, except per share data) | 2024 | % of Revenues(1) | 2023 | % of Revenues(1) | $ Change(1) | % Change(1) | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net revenues | $ | 2,973.5 | 100.0 | % | $ | 3,490.7 | 100.0 | % | $ | (517.2) | (14.8) | % | ||||||||
| Cost of goods sold | 2,540.0 | 85.4 | % | 2,904.6 | 83.2 | % | (364.6) | (12.6) | % | |||||||||||
| Gross profit | 433.5 | 14.6 | % | 586.1 | 16.8 | % | (152.6) | (26.0) | % | |||||||||||
| Selling, general, and administrative expenses ("SG&A") | 280.0 | 9.4 | % | 267.7 | 7.7 | % | 12.5 | 4.7 | % | |||||||||||
| Amortization | 23.0 | 0.8 | % | 17.7 | 0.5 | % | 5.3 | 29.7 | % | |||||||||||
| Goodwill impairment (Note 7) | 30.3 | 1.0 | % | — | — | % | 30.3 | NM | ||||||||||||
| Total operating expenses | 333.3 | 11.2 | % | 285.4 | 8.2 | % | 48.0 | 16.8 | % | |||||||||||
| Operating income | 100.2 | 3.4 | % | 300.7 | 8.6 | % | (200.5) | (66.7) | % | |||||||||||
| Interest expense, net | 21.1 | 0.7 | % | 20.5 | 0.6 | % | 0.5 | 2.6 | % | |||||||||||
| Loss on note repurchase (Note 9) | 32.7 | 1.1 | % | — | — | % | 32.7 | NM | ||||||||||||
| Non-operating loss | 8.0 | 0.3 | % | 1.0 | — | % | 7.0 | 718.9 | % | |||||||||||
| Income before income taxes | 38.4 | 1.3 | % | 279.2 | 8.0 | % | (240.8) | (86.3) | % | |||||||||||
| Provision for income taxes | 25.4 | 0.9 | % | 63.3 | 1.8 | % | (37.9) | (59.9) | % | |||||||||||
| Net income | $ | 13.0 | 0.4 | % | $ | 215.9 | 6.2 | % | $ | (202.9) | (94.0) | % | ||||||||
| Diluted earnings per share | $ | 0.44 | $ | 6.23 | $ | (5.79) | (92.9) | % | ||||||||||||
| Diluted weighted average shares outstanding | 29.5 | 35.4 | (5.9) | (16.7) | % |
(1) Amounts are calculated based on unrounded numbers and therefore may not recalculate using the rounded numbers provided. In addition, percentages may not add in total due to rounding.
NM: Not meaningful.
Net revenues decreased primarily due to product mix and lower unit sales related to market conditions.
Gross profit as a percentage of revenue decreased primarily due to deleverage, higher warranty expense, and operational challenges.
Operating expenses increased primarily due to the goodwill impairment charge associated with the Chris-Craft reporting unit, a full year of Lithionics operations and increased intangible amortization, start-up costs associated with the launch of the Grand Design motorized business, and strategic investments in engineering, digital technology development, and increased data and information technology capabilities, partially offset by lower incentive-based compensation.
The loss on note repurchase recorded in Fiscal 2024 is related to the refinancing of the 2025 Convertible Notes. Refer to Note 9 in the Notes to Consolidated Financial Statements, included in Item 8 of Part II in this Annual Report on Form 10-K for further information.
Our effective tax rate increased primarily due to the impact of the non-deductible debt inducement loss and non-deductible goodwill impairment over a lower pretax income.
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Non-GAAP Reconciliation
The following table reconciles net income to consolidated EBITDA and Adjusted EBITDA for Fiscal 2024 and 2023:
| (in millions) | 2024 | 2023 | ||||
|---|---|---|---|---|---|---|
| Net income | $ | 13.0 | $ | 215.9 | ||
| Interest expense, net | 21.1 | 20.5 | ||||
| Provision for income taxes | 25.4 | 63.3 | ||||
| Depreciation | 35.6 | 29.2 | ||||
| Amortization | 23.0 | 17.7 | ||||
| EBITDA | 118.1 | 346.6 | ||||
| Acquisition-related costs | 1.5 | 7.5 | ||||
| Litigation reserves | — | (0.4) | ||||
| Change in fair value of note receivable and other investments | 6.0 | — | ||||
| Contingent consideration fair value adjustment | 1.1 | 0.6 | ||||
| Goodwill impairment (Note 7) | 30.3 | — | ||||
| Loss on note repurchase (Note 9) | 32.7 | — | ||||
| Non-operating loss | 0.9 | 0.4 | ||||
| Adjusted EBITDA | $ | 190.6 | $ | 354.7 |
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Reportable Segment Performance Summary
Towable RV
The following is an analysis of key changes in our Towable RV segment for Fiscal 2024 and 2023:
| (in millions, except ASP and units) | 2024 | % of Revenues (1) | 2023 | % of Revenues (1) | $ Change(1) | % Change(1) | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net revenues | $ | 1,318.8 | $ | 1,415.3 | $ | (96.5) | (6.8) | % | ||||||||||
| Adjusted EBITDA | 122.4 | 9.3 | % | 172.1 | 12.2 | % | (49.7) | (28.9) | % | |||||||||
| Average Selling Price ("ASP")(2) | 41,004 | 45,568 | (4,564) | (10.0) | % | |||||||||||||
| Unit deliveries | 2024 | Product Mix(3) | 2023 | Product Mix(3) | Unit Change | % Change | ||||||||||||
| Travel trailer | 21,636 | 67.5 | % | 21,352 | 68.8 | % | 284 | 1.3 | % | |||||||||
| Fifth wheel | 10,403 | 32.5 | % | 9,701 | 31.2 | % | 702 | 7.2 | % | |||||||||
| Total Towable RV | 32,039 | 100.0 | % | 31,053 | 100.0 | % | 986 | 3.2 | % | |||||||||
| August 31, 2024 | August 26, 2023 | Change(1) | % Change(1) | |||||||||||||||
| Backlog(4) | ||||||||||||||||||
| Units | 4,850 | 5,111 | (261) | (5.1) | % | |||||||||||||
| Dollars | $ | 137.1 | $ | 208.1 | $ | (71.0) | (34.1) | % | ||||||||||
| Dealer Inventory | ||||||||||||||||||
| Units | 15,940 | 16,744 | (804) | (4.8) | % |
(1) Amounts are calculated based on unrounded numbers and therefore may not recalculate using the rounded numbers provided.
(2) ASP excludes off-invoice dealer incentives.
(3) Percentages may not add due to rounding differences.
(4) Our backlog includes all accepted orders from dealers which generally have been requested to be shipped within the next six months. Orders in backlog generally can be cancelled or postponed at the option of the dealer at any time without penalty; therefore, backlog may not necessarily be an accurate measure of future sales.
Net revenues decreased primarily due to a reduction in average selling price per unit related to product mix and targeted price reductions, partially offset by an increase in unit volume.
Adjusted EBITDA margin decreased primarily due to deleverage, higher warranty expense due to a favorable prior year trend, and operational challenges at the Winnebago branded towable business.
Backlog decreased due to current market conditions and a cautious dealer network as well as reduced order lead times due to production capacity.
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Motorhome RV
The following is an analysis of key changes in our Motorhome RV segment for Fiscal 2024 and 2023:
| (in millions, except ASP and units) | 2024 | % of Revenues(1) | 2023 | % of Revenues(1) | $ Change(1) | % Change(1) | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net revenues | $ | 1,279.8 | $ | 1,560.1 | $ | (280.4) | (18.0) | % | ||||||||||
| Adjusted EBITDA | 73.7 | 5.8 | % | 142.0 | 9.1 | % | (68.3) | (48.1) | % | |||||||||
| ASP(2) | 191,844 | 185,514 | 6,330 | 3.4 | % | |||||||||||||
| Unit deliveries | 2024 | Product Mix(3) | 2023 | Product Mix(3) | Unit Change | % Change | ||||||||||||
| Class A | 1,625 | 24.0 | % | 2,142 | 25.5 | % | (517) | (24.1) | % | |||||||||
| Class B | 2,278 | 33.7 | % | 3,845 | 45.8 | % | (1,567) | (40.8) | % | |||||||||
| Class C | 2,854 | 42.2 | % | 2,407 | 28.7 | % | 447 | 18.6 | % | |||||||||
| Total Motorhome RV | 6,757 | 100.0 | % | 8,394 | 100.0 | % | (1,637) | (19.5) | % | |||||||||
| August 31, 2024 | August 26, 2023 | Change(1) | % Change(1) | |||||||||||||||
| Backlog(4) | ||||||||||||||||||
| Units | 897 | 3,828 | (2,931) | (76.6) | % | |||||||||||||
| Dollars | $ | 234.4 | $ | 688.6 | $ | (454.1) | (66.0) | % | ||||||||||
| Dealer Inventory | ||||||||||||||||||
| Units | 3,933 | 4,068 | (135) | (3.3) | % |
(1) Amounts are calculated based on unrounded numbers and therefore may not recalculate using the rounded numbers provided.
(2) ASP excludes off-invoice dealer incentives.
(3) Percentages may not add due to rounding differences.
(4) Our backlog includes all accepted orders from dealers which generally have been requested to be shipped within the next six months. Orders in backlog can be cancelled or postponed at the option of the dealer at any time without penalty; therefore, backlog may not necessarily be an accurate measure of future sales.
Net revenues decreased primarily due to a decline in unit volume related to market conditions and higher levels of discounts and allowances, partially offset by price increases related to higher motorized chassis cost.
Adjusted EBITDA margin decreased due to deleverage, higher warranty expense, and operational challenges, partially offset by cost containment efforts.
Backlog decreased due to current market conditions and a cautious dealer network.
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Marine
The following is an analysis of key changes in our Marine segment for Fiscal 2024 and 2023:
| (in millions, except ASP and units) | 2024 | % of Revenues(1) | 2023 | % of Revenues(1) | $ Change(1) | % Change(1) | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net revenues | $ | 325.5 | $ | 469.7 | $ | (144.2) | (30.7) | % | ||||||||||
| Adjusted EBITDA | 25.6 | 7.9 | % | 60.5 | 12.9 | % | (34.8) | (57.6) | % | |||||||||
| ASP(2) | 80,641 | 83,060 | (2,419) | (2.9) | % | |||||||||||||
| Unit deliveries | 2024 | 2023 | Unit Change | % Change | ||||||||||||||
| Boats | 4,149 | 5,714 | (1,565) | (27.4) | % | |||||||||||||
| August 31, 2024 | August 26, 2023 | Change(1) | % Change(1) | |||||||||||||||
| Backlog(3) | ||||||||||||||||||
| Units | 3,403 | 2,545 | 858 | 33.7 | % | |||||||||||||
| Dollars | $ | 260.0 | $ | 194.7 | $ | 65.2 | 33.5 | % | ||||||||||
| Dealer Inventory(4) | ||||||||||||||||||
| Units | 2,564 | 3,376 | (812) | (24.1) | % |
(1) Amounts are calculated based on unrounded numbers and therefore may not recalculate using the rounded numbers provided.
(2) ASP excludes off-invoice dealer incentives.
(3) Our backlog includes all accepted orders from dealers which generally have been requested to be shipped within the next six months. Orders in backlog generally can be cancelled or postponed at the option of the dealer at any time without penalty; therefore, backlog may not necessarily be an accurate measure of future sales.
(4) Due to the nature of the Marine industry, this amount includes a higher proportion of retail sold units than our other segments.
Net revenues decreased primarily due to a decline in unit volume related to market conditions, and product mix.
Adjusted EBITDA margin decreased due to deleverage, partially offset by lower incentive-based compensation and cost containment efforts.
Backlog increased primarily driven by the improvement in inventory position with dealers and continued market share growth.
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Analysis of Financial Condition, Liquidity, and Capital Resources
Cash Flows
The following table summarizes our cash flows from total operations for Fiscal 2024 and 2023:
| (in millions) | 2024 | 2023 | ||||
|---|---|---|---|---|---|---|
| Total cash provided by (used in): | ||||||
| Operating activities | $ | 143.9 | $ | 294.5 | ||
| Investing activities | (45.9) | (170.0) | ||||
| Financing activities | (77.0) | (96.8) | ||||
| Net increase in cash and cash equivalents | $ | 21.0 | $ | 27.7 |
Operating Activities
During Fiscal 2024, cash provided by operating activities was $143.9 million compared to $294.5 million in Fiscal 2023. The decrease in operating cash flow is primarily driven by lower profitability adjusted for non-cash items, an increase in accounts receivable due to timing of invoicing and collections, and changes in inventory levels due to market conditions, partially offset by favorable changes in accounts payable balances and timing of payments.
Investing Activities
Cash used in investing activities decreased compared to prior year, primarily due to our acquisition of Lithionics during the third quarter of Fiscal 2023 and elevated capital expenditures in Fiscal 2023 to support operational expansion and organic growth.
Financing Activities
Cash used in financing activities decreased compared to prior year, primarily due to $39.1 million of net cash proceeds related to the debt refinancing, partially offset by higher share repurchases compared to prior year.
Debt and Capital
We maintain a $350.0 million asset-based revolving credit facility ("ABL Credit Facility") with a maturity date of July 15, 2027 subject to certain factors which may accelerate the maturity date. As of August 31, 2024, we had no borrowings against the ABL Credit Facility and $330.9 million in cash and cash equivalents. Our cash and cash equivalent balances consist of high quality, short-term money market instruments.
On January 23, 2024, we issued $350.0 million in aggregate principal amount of 3.25% unsecured convertible senior notes due 2030 ("2030 Convertible Notes").
On July 8, 2020, we closed our private offering (the “Senior Secured Notes Offering”) of $300.0 million aggregate principal amount of 6.25% Senior Secured Notes due 2028 (the “Senior Secured Notes”).
On November 1, 2019, we issued $300.0 million in aggregate principal amount of 1.5% unsecured Convertible Senior Notes due 2025 (“2025 Convertible Notes”). On January 18, 2024, we entered into privately negotiated transactions (the "2025 Convertible Note Repurchases") with certain holders of the 2025 Convertible Notes to repurchase $240.7 million aggregate principal amount of the 2025 Convertible Notes using proceeds received from the 2030 Convertible Notes.
As of August 31, 2024, we had $59.1 million of debt maturing in the next twelve months that is classified as current on our Consolidated Balance Sheets.
We evaluate the financial stability of the counterparties for the 2030 Convertible Notes, the 2025 Convertible Notes, the Senior Secured Notes, and the ABL Credit Facility, and will continue to monitor counterparty risk on an on-going basis.
Refer to Note 9 in the Notes to Consolidated Financial Statements, included in Item 8 of Part II in this Annual Report on Form 10-K for additional information.
Working Capital
Working capital as of August 31, 2024 and August 26, 2023 was $584.0 million and $600.7 million, respectively. We currently expect cash on hand, funds generated from operations, and the borrowing available under our ABL Credit Facility to be sufficient to cover both short-term and long-term operating requirements.
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Capital Expenditures
We anticipate capital expenditures in Fiscal 2025 of approximately $50.0 million to $60.0 million. We will continue to support organic growth through facility improvements to benefit a safer operating environment, operational improvements, and investments in software and our digital capabilities. We believe cash on hand, funds generated from operations, and the borrowing capacity available under our ABL Credit Facility and other debt instruments will be sufficient to support our capital expenditures for the foreseeable future.
Share Repurchases and Dividends
We repurchase our common stock and pay dividends pursuant to programs approved by our Board of Directors. Our long-term capital allocation strategy is to first fund operations and investments in growth, maintain reasonable liquidity, maintain a leverage ratio that reflects a prudent capital structure in light of the cyclical industries we compete in, and then return excess cash over time to shareholders through dividends and share repurchases. Refer to Item 5 of Part II of this Annual Report on Form 10-K for discussion about our share repurchase program and dividend declared on August 15, 2024.
Cash Requirements
Our cash requirements within the next twelve months include accounts payable, current maturities of long-term debt, accrued expenses, purchase commitments and other current liabilities.
Our cash requirements greater than twelve months from various contractual obligations and commitments include:
Debt Obligations and Interest Payments
Refer to Note 9 in the Notes to Consolidated Financial Statements, included in Item 8 of Part II in this Annual Report on Form 10-K for information regarding our debt and the timing of expected future principal and interest payments. Interest payments are based on fixed interest rates for the 2030 Convertible Notes, the 2025 Convertible Notes, and the Senior Secured Notes.
Operating and Finance Leases
Refer to Note 10 in the Notes to Consolidated Financial Statements, included in Item 8 of Part II in this Annual Report on Form 10-K for information regarding our lease obligations and the timing of expected future payments.
Deferred Compensation Obligations
Refer to Note 11 in the Notes to Consolidated Financial Statements, included in Item 8 of Part II in this Annual Report on Form 10-K for information regarding our deferred compensation plans. We expect to pay $1.7 million in the next 12 months and $6.6 million beyond 12 months.
Contracted Services
Contracted services include agreements with third-party service providers primarily for software, payroll services, and equipment maintenance services for periods up to Fiscal 2028. We expect to pay approximately $22.6 million in the next 12 months and approximately $19.6 million beyond 12 months.
Contingent Repurchase Obligations
Refer to Note 12 in the Notes to Consolidated Financial Statements, included in Item 8 of Part II in this Annual Report on Form 10-K for information regarding our contingent repurchase commitment and estimated obligation, most of which we expect to expire within one year.
We expect to satisfy our short-term and long-term obligations through a combination of cash on hand, funds generated from operations, and the borrowing capacity available under our ABL Credit Facility and other debt instruments.
Critical Accounting Policies and Estimates
The consolidated financial statements are prepared in accordance with GAAP. In connection with the preparation of our financial statements, we are required to make assumptions and estimates about future events and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses, and the related disclosures. We base our assumptions, estimates, and judgments on historical experience, current trends, and other factors believed to be relevant at the time the consolidated financial statements are prepared. Because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.
Our critical accounting policies are discussed in Note 1 in the Notes to Consolidated Financial Statements, included in Item 8 of Part II in this Annual Report on Form 10-K. We believe that the following accounting policies and estimates are the most critical to aid in fully understanding and evaluating our reported financial results. These estimates require our most difficult, subjective, or complex judgments because they relate to matters that are inherently uncertain. We have reviewed these critical accounting policies and estimates and related disclosures with the Audit Committee of our Board of Directors.
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We have not made any material changes during the past three fiscal years, nor do we believe there is a reasonable likelihood of a material future change to the accounting methodologies for the areas described below.
Accounting for Business Combinations
We account for business combinations under the acquisition method of accounting. This method requires the recording of acquired assets, including separately identifiable intangible assets, and assumed liabilities at their acquisition date fair values. The excess of the purchase price over the fair value of assets acquired and liabilities assumed is recorded as goodwill. Determining the fair value of assets acquired and liabilities assumed requires management’s judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash flows, discount rates, royalty rates and asset lives, among other items.
We used the income approach to value certain intangible assets. Under the income approach, an intangible asset’s fair value is equal to the present value of future economic benefits to be derived from ownership of the asset. We used the income approach known as the relief from royalty method to value the fair value of the trade names. The relief from royalty method is based on the hypothetical royalty stream that would be received if we were to license the trade name and was based on expected revenues. The fair value of the dealer network was estimated using an income approach known as the cost to recreate/cost savings method. This method uses the replacement of the asset as an indicator of the fair value of the asset. The determination of the fair value of other assets acquired and liabilities assumed involves assessing factors such as the expected future cash flows associated with individual assets and liabilities and appropriate discount rates at the date of the acquisition.
Goodwill and Indefinite-lived Intangible Assets
We test goodwill and other indefinite-lived intangible assets (trade names in certain instances) for impairment at least annually in the fourth quarter and more frequently if events or circumstances occur that would indicate a reduction in fair value. Our test of impairment begins by either performing a qualitative evaluation or a quantitative test:
•Qualitative evaluation - Performed to determine whether it is more likely than not that the carrying value of goodwill or the indefinite-lived trade name exceeds the fair value of the asset. During our qualitative assessment, we make significant estimates, assumptions, and judgments, including, but not limited to, the macroeconomic conditions, industry and market conditions, cost factors, overall financial performance of the Company and the reporting units, changes in our share price, and relevant company-specific events. If we determine that it is more likely than not that the carrying value of the goodwill or indefinite-lived trade name exceeds the fair value, we perform the quantitative test to determine the amount of the impairment.
•Quantitative test - Used to calculate the fair value of goodwill or the indefinite-lived trade name. If the carrying value of the reporting unit or indefinite-lived trade name exceeds the fair value, the impairment is calculated as the difference between the carrying value and fair value. Our goodwill fair value model uses a blend of the income (discounted future cash flow) and market (guideline public company) approaches, which includes the use of significant unobservable inputs (Level 3 inputs). Our indefinite-lived trade name fair value model uses the income (relief-from-royalty) approach, which includes the use of significant unobservable inputs (Level 3 inputs). During these valuations, we make significant estimates, assumptions, and judgments, including current and projected future levels of income based on management’s plans, business trends, market and economic conditions, and market-participant considerations. Actual results may differ from assumed and estimated amounts, which could result in future impairment losses.
During the fourth quarter of Fiscal 2024, we completed our annual assessment of indefinite-lived intangible assets and determined that the carrying value of the Chris-Craft reporting unit exceeded its fair value, resulting in a $30.3 million impairment charge, which represents the full goodwill balance attributable to the reporting unit. Comparatively, no impairments were recorded in Fiscal 2023 and Fiscal 2022.
For further information regarding goodwill and intangible assets, see Note 7 in the Notes to Consolidated Financial Statements, included in Item 8 of Part II in this Annual Report on Form 10-K.
Warranty
We provide certain service and warranty on our products. Estimated costs related to product warranty are accrued at the time of sale and are based upon past warranty claims and unit sales history. Estimates are adjusted as needed to reflect actual costs incurred as information becomes available.
In addition to the costs associated with the contractual warranty coverage provided on our products, we also occasionally incur costs as a result of additional service actions not covered by our warranties, including product recalls and customer satisfaction actions. Although we estimate and reserve for the cost of these service actions, there can be no assurance that expense levels will remain at current levels or such reserves will continue to be adequate.
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A significant increase in dealership labor rates, the cost of parts, or the frequency of claims could have a material adverse impact on our operating results for the period or periods in which such claims or additional costs materialize. A hypothetical change of a 10% increase or decrease in our warranty liability as of August 31, 2024 would not have a material effect on our net income.
New Accounting Pronouncements
For a summary of new applicable accounting pronouncements, see Note 1 in the Notes to Consolidated Financial Statements, included in Item 8 of Part II in this Annual Report on Form 10-K.