E-Z-GO 2006 Annual Report Download - page 49

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
referred to above results in an accurate evaluation of existing losses in the portfolio based on prior trends and experience, changes in the assump-
tions or trends within reasonable historical volatility may have a material impact on our allowance for losses. The allowance for losses on finance
receivables currently represents 1.1% of total finance receivables. During the last five years, net charge-offs as a percentage of finance receivables
have ranged from 0.38% to 2.08%.
Long-Term Contracts
We make a substantial portion of our sales to government customers pursuant to long-term contracts. These contracts require development and
delivery of products over multiple years and may contain fixed-price purchase options for additional products. We accounted for these long-term
contracts under the percentage-of-completion method of accounting.
Under the percentage-of-completion method, we estimate profit as the difference between total estimated revenue and total estimated cost of a
contract and recognize that profit over the contract term based on either input (e.g., costs incurred under the cost-to-cost method, which typically
is used for development effort) or output (e.g., units delivered under the units-of-delivery method, which is used for production effort), as appro-
priate under the circumstances. The percentage-of-completion method of accounting involves the use of various estimating techniques to project
costs at completion and, in some cases includes estimates of recoveries asserted against the customer for changes in specifications. Due to the
size, length of time and nature of many of our contracts, the estimation of total contract costs and revenue through completion is complicated and
subject to many variables relative to the outcome of future events over a period of several years. We are required to make numerous assumptions
and estimates relating to items such as expected engineering requirements, complexity of design and related development costs, performance of
subcontractors, availability and cost of materials, labor productivity and cost, overhead and capital costs, manufacturing efficiencies and the
achievement of contract milestones, including product deliveries.
Our cost estimation process is based on the professional knowledge and experience of engineers and program managers along with finance pro-
fessionals. We update our projections of costs at least semiannually or when circumstances significantly change. Adjustments to projected costs
are recognized in earnings when determinable. Anticipated losses on contracts are recognized in full in the period in which losses become proba-
ble and estimable. Due to the significance of judgment in the estimation process described above, it is likely that materially different revenues
and/or cost of sales amounts could be recorded if we used different assumptions or if the underlying circumstances were to change. Our earnings
could be reduced by a material amount resulting in a charge to earnings if (a) total estimated contract costs are significantly higher than expected
due to changes in customer specifications prior to contract amendment, (b) total estimated contract costs are significantly higher than previously
estimated due to cost overruns or inflation, (c) there is a change in engineering efforts required during the development stage of the contract or (d)
we are unable to meet contract milestones.
Goodwill
We evaluate the recoverability of goodwill annually in the fourth quarter or more frequently if events or changes in circumstances, such as
declines in sales, earnings or cash flows, or material adverse changes in the business climate, indicate that the carrying value of an asset might be
impaired. We completed our annual impairment test in the fourth quarter of 2006 using the estimates from our long-term strategic plans. No
adjustment was required to the carrying value of our goodwill based on the analysis performed.
Goodwill is considered to be impaired when the net book value of a reporting unit exceeds its estimated fair value. Fair values are primarily estab-
lished using a discounted cash flow methodology using assumptions consistent with market participants. The determination of discounted cash
flows is based on the businesses’ strategic plans and long-range planning forecasts. The revenue growth rates included in the forecasts represent
our best estimates based on current and forecasted market conditions, and the profit margin assumptions are projected by each reporting unit
based on the current cost structure and anticipated net cost reductions. If different assumptions were used in these forecasts, the related undis-
counted cash flows used in measuring impairment could be different, potentially resulting in an impairment charge.
The impact of reducing our fair value estimates by 10% would have no impact on our goodwill assessment, with the exception of two reporting
units as described below. Assuming a 10% reduction in our fair value estimates, the carrying value of these reporting units would approximate or
exceed fair value.
Our operating plans and projections anticipate investments in capital expenditures at our Fluid Handling Products reporting unit to resolve
current capacity issues as well as to capture additional business in the oil and gas markets over the next two years. The related volume increases
are anticipated to result in approximately 25% annual operating profit growth over this period. In the remaining five-year planning period, we
anticipate an annual operating profit growth rate of approximately 7%, driven by anticipated revenue growth of 4% annually with increased profit
margins from improvements resulting from ongoing transformation efforts. Should the revenue growth rates over the next two years approximate