Blue Bird Corp (BLBD) FY 2021 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of operations of the Company should be read in conjunction with the Company’s audited financial statements for the fiscal years ended October 2, 2021, October 3, 2020 and September 28, 2019 and related notes appearing elsewhere in this Report. Our actual results may not be indicative of future performance. This discussion and analysis contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those discussed or incorporated by reference in the sections of this Report titled “Special Note Regarding Forward-Looking Statements” and “Risk Factors.” Actual results may differ materially from those contained in any forward-looking statements. Certain monetary amounts, percentages and other figures included in this Report have been subjected to rounding adjustments. Accordingly, figures shown as totals in certain tables may not be the arithmetic aggregation of the figures that precede them, and figures expressed as percentages in the text may not total 100% or, as applicable, when aggregated, may not be the arithmetic aggregation of the percentages that precede them.

Executive Overview

Blue Bird is the leading independent designer and manufacturer of school buses. Our longevity and reputation in the school bus industry have made Blue Bird an iconic American brand. We distinguish ourselves from our principal competitors by dedicating our focus to the design, engineering, manufacture and sale of school buses, and related parts. As the only principal manufacturer of chassis and body production specifically designed for school bus applications, Blue Bird is recognized as an industry leader for school bus innovation, safety, product quality/reliability/durability, efficiency, and lower operating costs. In addition, Blue Bird is the market leader in alternative powered product offerings with its propane, gasoline, CNG, and electric powered school buses.

Blue Bird sells its buses and parts through an extensive network of U.S. and Canadian dealers that, in their territories, are exclusive to Blue Bird on Type C and Type D school buses. Blue Bird also sells directly to major fleet operators, the U.S. Government, state governments, and authorized dealers in a number of foreign countries.

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Impact of COVID-19 on Our Business

Beginning in our second fiscal quarter of 2020, the novel coronavirus known as "COVID-19" began to spread throughout the world, resulting in a global pandemic. The pandemic triggered a significant downturn in global commerce as early as February 2020 and the challenging market conditions are expected to continue for an extended period of time. In an effort to contain the spread of COVID-19, maintain the well-being of our employees and stakeholders, address the reduced demand from our customers and be responsive and efficient with supply chain constraints, management took decisive actions including closing our manufacturing facilities for two weeks in April 2020 and implementing stringent safety protocols, including administering COVID-19 testing for all manufacturing and office employees and requesting office employees to work from home. Management also decided to cease production for a full week in each of March and May 2021 due to supply chain disruptions that resulted in a shortage of critical components. Additionally, management closely monitors the expected receipt of critical components on a daily basis and has had to cease part or all of production for shorter periods of time as a result of supply shortages.

These temporary closures of our manufacturing facility did not materially impact our operations during fiscal 2020 or the first half of fiscal 2021 as we did not need to operate at full capacity to fulfill sales orders at those times. However, such supply chain disruptions did significantly impact our operations and results during the second half of fiscal 2021 due to higher purchasing costs, including freight costs incurred to expedite receipt of critical components, increased manufacturing inefficiencies and our inability to complete the production of buses to fulfill sales orders. Specifically, management estimates that the sale of approximately 2,000 units was deferred from fiscal 2021 into fiscal 2022 as a result of the shortage of critical components that prevented the Company from initiating or completing, as applicable, the production process for certain units that were otherwise scheduled to be delivered to customers during the year. Including these units, the Company's backlog exceeded 4,200 units as of October 2, 2021 as demand for our products remains strong, with no sales orders canceled as a result of delays in our production process. The Company has also experienced increased purchase costs for certain of its raw materials during the pandemic that have negatively impacted the gross profit it recognized on sales, particularly during the second half of fiscal 2021. The decreased gross profit is expected to continue into the first half of fiscal 2022 given the increased purchase costs we incurred acquiring the inventory that we accumulated at the end of fiscal 2021 as a result of our inability to build and sell buses due to critical component shortages. In response, in July 2021 the Company announced two sales price increases that will apply to new sales orders and are intended to mitigate the impact of rising purchase costs on our operations and results. In general, management believes that such supply chain disruptions will continue in future periods and will materially impact our results if we are unable to i) produce during quarters having higher sales volumes and/or ii) pass along rising costs to our customers. Additionally, although we have not experienced any pervasive COVID-19 illnesses to-date, if we were to experience some form of outbreak within our facilities, we would take all appropriate measures to protect the health and safety of our employees, which could include another temporary halt in production.

The pandemic has resulted, and is likely to continue to result, in significant economic disruption and has adversely affected our business. It will continue to adversely impact our business into fiscal year 2022 and perhaps beyond. Significant uncertainty exists concerning the magnitude of the impact and duration of the COVID-19 pandemic and its impact on the overall U.S and global economy. The duration of any demand reductions, production and supply chain disruptions, and related financial impacts on our business cannot be estimated at this time.

The continuing impacts from COVID-19 on the Company's operations in fiscal 2021 negatively affected our revenue, profit and cash flows. We continue to monitor and assess the level of future customer demand, the ability of school boards to make decisions regarding maintaining normal in-person learning in the foreseeable future, the ability of suppliers to resume and/or maintain normal operations and to provide parts and supplies in sufficient quantities to meet our production needs, the ability of our employees to continue to work, and our ability to maintain continuous production as we plan for fiscal 2022 and beyond. See PART I, Item 1A. "Risk Factors," of this Report for a discussion of the material risks we believe we face particularly related to the COVID-19 pandemic.

The Company has also taken actions to control spending and secure adequate liquidity, including headcount rationalization, changes to the minimum required financial covenants resulting from the execution of a fourth amendment to the Credit Agreement in November 2021 and raising $75.0 million of net proceeds through the issuance and sale of an aggregate 4,687,500 shares of common stock at $16.00 per share in a private placement transaction on December 15, 2021. Further detail and discussion of the Credit Agreement amendment and private placement transaction can be found in this Report in the "Liquidity and Capital Resources" section of this Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" and in Note 19, Subsequent Events, to the Company’s consolidated financial statements, respectively. Even with adequate liquidity, we are evaluating and considering further actions to reduce costs and spending across our organization to be responsive to potential longer-term impacts on our business from the pandemic. Our actions may include reducing hiring activities, limiting discretionary spending, limiting spending on capital investment projects or other steps necessary to preserve adequate liquidity. We may also pursue raising additional capital via an equity or debt offering. We will continue to actively monitor the situation and may need to take further actions required by federal, state or local authorities, or enact measures we determine are in the best interests of our employees, customers, suppliers and shareholders. For further details and discussion about our liquidity, refer to the following "Liquidity and Capital Resources" section of this Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" of this Report.

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Factors Affecting Our Revenues

Our revenues are driven primarily by the following factors:

•Property tax revenues. Property tax revenues are one of the major sources of funding for school districts, and therefore new school buses. Property tax revenues are a function of land and building prices, based on assessments of property value by state or county assessors and millage rates voted by the local electorate.

•Student enrollment and delivery mechanisms for learning. Increases or decreases in the number of school bus riders have a direct impact on school district demand. Due to the COVID-19 pandemic and evolving protocols for social distancing and public health concerns, the future form of educational delivery remains uncertain, and increased remote learning could reasonably be expected to decrease the number of school bus riders.

•Revenue mix. We are able to charge more for certain of our products (e.g., Type C propane powered school buses, electric powered buses, Type D buses, and buses with higher option content) than other products. The mix of products sold in any fiscal period can directly impact our revenues for the period.

•Strength of the dealer network. We rely on our dealers, as well as a small number of major fleet operators, to be the direct point of contact with school districts and their purchasing agents. An effective dealer is capable of expanding revenues within a given school district by matching that district’s needs to our capabilities, offering options that would not otherwise be provided to the district.

•Pricing. Our products are sold to school districts throughout the U.S. and Canada. Each state and each Canadian province has its own set of regulations that govern the purchase of products, including school buses, by their school districts. We and our dealers must navigate these regulations, purchasing procedures, and the districts’ specifications in order to reach mutually acceptable price terms. Pricing may or may not be favorable to us, depending upon a number of factors impacting purchasing decisions.

•Buying patterns of major fleets. Major fleets regularly compete against one another for existing accounts. Fleets are also continuously trying to win the business of school districts that operate their own transportation services. These activities can have either a positive or negative impact on our sales, depending on the brand preference of the fleet that wins the business. Major fleets also periodically review their fleet sizes and replacement patterns due to funding availability as well as the profitability of existing routes. These actions can impact total purchases by fleets in a given year.

•Seasonality. Historically, our sales have been subject to seasonal variation based on the school calendar with the peak season during our third and fourth fiscal quarters. Sales during the third and fourth fiscal quarters are typically greater than the first and second fiscal quarters due to the desire of municipalities to have any new buses that they order available to them at the beginning of the new school year. With the COVID-19 pandemic impact on school systems and the uncertainty regarding (i) in-person schooling schedules and duration and (ii) the severity and duration of ongoing supply chain constraints, seasonality has become unpredictable. Seasonality and variations from historical seasonality have impacted the comparison of results between fiscal periods.

Factors Affecting Our Expenses and Other Items

Our expenses and other line items in our Consolidated Statements of Operations are principally driven by the following factors:

•Cost of goods sold. The components of our cost of goods sold consist of material costs (principally powertrain components, steel and rubber, as well as aluminum and copper) including freight costs, labor expense, and overhead. Our cost of goods sold may vary from period to period due to changes in sales volume, efforts by certain suppliers to pass through the economics associated with key commodities, fluctuations in freight costs, design changes with respect to specific components, design changes with respect to specific bus models, wage increases for plant labor, productivity of plant labor, delays in receiving materials and other logistical challenges, and the impact of overhead items such as utilities.

•Selling, general and administrative expenses. Our selling, general and administrative expenses include costs associated with our selling and marketing efforts, engineering, centralized finance, human resources, purchasing, and information technology services, along with other administrative matters and functions. In most instances, other than direct costs associated with sales and marketing programs, the principal component of these costs is salary expense. Changes from period to period are typically driven by the number of our employees, as well as by merit increases provided to experienced personnel.

•Interest expense. Our interest expense relates to costs associated with our debt instruments and reflects both the amount of indebtedness and the interest rate that we are required to pay on our debt. Interest expense also includes unrealized gains or losses from interest rate hedges, if any, and changes in the fair value of interest rate derivatives not designated in hedge accounting relationships, if any, as well as expenses related to debt guarantees, if any.

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•Income taxes. We make estimates of the amounts to recognize for income taxes in each tax jurisdiction in which we operate. In addition, provisions are established for withholding taxes related to the transfer of cash between jurisdictions and for uncertain tax positions taken.

•Other income/expense, net. This balance includes periodic pension expense or income as well as gains or losses on foreign currency, if any. Other immaterial amounts not associated with operating expenses may also be included in this balance.

•Equity in net income of non-consolidated affiliate. We include in this line item our 50% share of net income or loss from our investment in Micro Bird, our unconsolidated Canadian joint venture.

Key Non-GAAP Financial Measures We Use to Evaluate Our Performance

The consolidated financial statements included in this Report in Item 8. "Financial Statements and Supplementary Data" are prepared in conformity with accounting principles generally accepted in the U.S. (“U.S. GAAP”). This Report also includes the following financial measures that are not prepared in accordance with U.S. GAAP ("non-GAAP"): “Adjusted EBITDA,” “Adjusted EBITDA Margin,” and “Free Cash Flow.” Adjusted EBITDA and Free Cash Flow are financial metrics that are utilized by management and the board of directors to determine (a) the annual cash bonus payouts, if any, to be made to certain members of management based upon the terms of the Company’s Management Incentive Plan, and (b) whether the performance criteria have been met for the vesting of certain equity awards granted annually to certain members of management based upon the terms of the Company’s Omnibus Equity Incentive Plan. Additionally, consolidated EBITDA, which is an adjusted EBITDA metric defined by our Amended Credit Agreement (defined subsequently herein) that could differ from Adjusted EBITDA discussed above as the adjustments to the calculations are not uniform, is used to determine the Company's ongoing compliance with several financial covenant requirements, including being utilized in the denominator of the calculation of the TNLR, as and when applicable. Accordingly, management views these non-GAAP financial metrics as key for the above purposes and as a useful way to evaluate the performance of our operations as discussed further below.

Adjusted EBITDA is defined as net income or loss prior to interest income; interest expense including the component of operating lease expense (which is presented as a single operating expense in selling, general and administrative expenses in our U.S. GAAP financial statements) that represents interest expense on lease liabilities; income taxes; and depreciation and amortization including the component of operating lease expense (which is presented as a single operating expense in selling, general and administrative expenses in our U.S. GAAP financial statements) that represents amortization charges on right-of-use lease assets; as adjusted for certain non-cash charges or credits that we may record on a recurring basis such as stock-compensation expense and unrealized gains or losses on certain derivative financial instruments; net gains or losses on the disposal of assets as well as certain charges such as (i) significant product design changes; (ii) transaction related costs; (iii) discrete expenses related to major cost cutting initiatives; or (iv) costs directly attributed to the COVID-19 pandemic. While certain of the charges that are added back in the Adjusted EBITDA calculation, such as transaction related costs and operational transformation and major product redesign initiatives, represent operating expenses that may be recorded in more than one annual period, the significant project or transaction giving rise to such expenses is not considered to be indicative of the Company’s normal operations. Accordingly, we believe that these, as well as the other credits and charges that comprise the amounts utilized in the determination of Adjusted EBITDA described above, should not be used in evaluating the Company’s ongoing annual operating performance. We define Adjusted EBITDA Margin as Adjusted EBITDA as a percentage of net sales. Adjusted EBITDA and Adjusted EBITDA Margin are not measures of performance defined in accordance with U.S. GAAP. The measures are used as a supplement to U.S. GAAP results in evaluating certain aspects of our business, as described below.

We believe that Adjusted EBITDA and Adjusted EBITDA Margin are useful to investors in evaluating our performance because the measures consider the performance of our ongoing operations, excluding decisions made with respect to capital investment, financing, and certain other significant initiatives or transactions as outlined in the preceding paragraph. We believe the non-GAAP measures offer additional financial metrics that, when coupled with the U.S. GAAP results and the reconciliation to U.S. GAAP results, provide a more complete understanding of our results of operations and the factors and trends affecting our business.

Adjusted EBITDA and Adjusted EBITDA Margin should not be considered as alternatives to net income or loss as an indicator of our performance or as alternatives to any other measure prescribed by U.S. GAAP as there are limitations to using such non-GAAP measures. Although we believe that Adjusted EBITDA and Adjusted EBITDA Margin may enhance an evaluation of our operating performance based on recent revenue generation and product/overhead cost control because they exclude the impact of prior decisions made about capital investment, financing, and certain other significant initiatives or transactions, (i) other companies in Blue Bird’s industry may define Adjusted EBITDA and Adjusted EBITDA Margin differently than we do and, as a result, they may not be comparable to similarly titled measures used by other companies in Blue Bird’s industry, and (ii) Adjusted EBITDA and Adjusted EBITDA Margin exclude certain financial information that some may consider important in evaluating our performance.

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We compensate for these limitations by providing disclosure of the differences between Adjusted EBITDA and U.S. GAAP results, including providing a reconciliation to U.S. GAAP results, to enable investors to perform their own analysis of our ongoing operating results.

Our measure of Free Cash Flow is used in addition to and in conjunction with results presented in accordance with U.S. GAAP and it should not be relied upon to the exclusion of U.S. GAAP financial measures. Free Cash Flow reflects an additional way of evaluating our liquidity that, when viewed with our U.S. GAAP results, provides a more complete understanding of factors and trends affecting our cash flows. We strongly encourage investors to review our financial statements and publicly-filed reports in their entirety and not to rely on any single financial measure.

We define Free Cash Flow as total cash provided by/used in operating activities as adjusted for net cash paid for the acquisition or disposal of fixed assets and intangible assets. We use Free Cash Flow, and ratios based on Free Cash Flow, to conduct and evaluate our business because, although it is similar to cash flow from operations, we believe it is a more conservative measure of cash flow since purchases of fixed assets and intangible assets are a necessary component of ongoing operations. Accordingly, we expect Free Cash Flow to be less than operating cash flows.

Our Segments

We manage our business in two operating segments, which are also our reportable segments: (i) the Bus segment, which involves the design, engineering, manufacture and sales of school buses and extended warranties; and (ii) the Parts segment, which includes the sale of replacement bus parts. Financial information is reported on the basis that it is used internally by the CODM in evaluating segment performance and deciding how to allocate resources to segments. The President and Chief Executive Officer of the Company has been identified as the CODM. Management evaluates the segments based primarily upon revenues and gross profit.

Consolidated Results of Operations for the fiscal years ended October 2, 2021 and October 3, 2020:

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The following provides the results of operations of Blue Bird's two reportable segments:

Net sales. Net sales were $684.0 million for fiscal 2021, a decrease of $195.2 million, or 22.2%, compared to $879.2 million for fiscal 2020. The decrease in net sales is attributed to the COVID-19 pandemic, which caused supply chain constraints that have limited the availability of certain critical components and thus, limited the number of buses the Company could produce and deliver.

Bus sales decreased $197.4 million, or 24.0%, reflecting a decrease in units booked that was partially offset by higher sales prices. In fiscal 2021, 6,679 units were booked compared to 8,878 units booked for fiscal 2020. The decrease in Bus revenue and volumes reflects the constraints on the Company's ability to produce and deliver buses due to COVID-19 driven shortages of critical components. The 1.0% increase in unit price for fiscal 2021 compared to fiscal 2020 mainly reflects pricing actions taken by management to partially offset increases in commodity costs, as well as product and customer mix changes.

Parts sales increased $2.2 million, or 3.9%, for fiscal 2021 compared to fiscal 2020, largely due to higher sales volume. Both fiscal 2020 and 2021 were significantly impacted by lower school bus units in operation due to school closures from the second quarter of fiscal 2020 through the second quarter of fiscal 2021 caused by the COVID-19 pandemic. However, the last half of fiscal 2021 experienced large increases in sales volume as schools prepared to resume in-person learning, including preparing buses to be fully operational for the first time in over a year.

Cost of goods sold. Total cost of goods sold was $611.9 million for fiscal 2021, a decrease of $171.2 million, or 21.9%, compared to $783.0 million for fiscal 2020. As a percentage of net sales, total cost of goods sold increased from 89.1% to 89.5%.

Bus segment cost of goods sold decreased $171.8 million, or 23.0%, for fiscal 2021 compared to fiscal 2020 due to reduced sales volumes. The average cost of goods sold per unit for fiscal 2021 was 2.3% higher compared to the average cost of goods sold per unit for fiscal 2020 due to increases in manufacturing costs from several COVID-19 related factors including hourly workforce absenteeism and supply chain disruptions that resulted in higher purchase costs for components and freight, all of which created manufacturing inefficiencies and higher costs.

The $0.6 million, or 1.6%, increase in parts segment cost of goods sold for fiscal 2021 compared to fiscal 2020 largely aligned with the increase in sales volume noted above, with slight variations due to product and channel mix.

Operating profit. Operating profit was $6.5 million for fiscal 2021, a decrease of $15.5 million, or 70.3%, compared to $22.0 million for fiscal 2020. Profitability was negatively impacted by a decrease of $24.1 million in gross profit, as outlined in the revenue and cost of goods sold discussions above. This decrease was partially offset by a decrease of $8.6 million in selling, general and administrative expenses as we have taken actions to control spending during the pandemic.

Interest expense. Interest expense was $9.7 million for fiscal 2021, a decrease of $2.6 million, or 21.0%, compared to $12.3 million for fiscal 2020. The decrease was largely attributable to fluctuations in the fair value of the interest rate collar (a liability balance) recorded in interest expense. The fiscal 2020 balance included a $2.6 million net increase in the fair value of the interest rate collar, while the fiscal 2021 balance included a $1.6 million decrease in fair value, thus resulting in a net $4.2 million decrease in interest expense. This decrease was partially offset by increased effective interest rates on outstanding borrowings.

Income taxes. We recorded income tax benefit of $1.2 million for fiscal 2021, compared to income tax expense of $1.5 million for fiscal 2020. This fluctuation was primarily attributed to lower amounts of taxable income in fiscal 2021 due to the ongoing impacts of COVID-19 on our operations as discussed above.

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The effective tax rate for fiscal 2021 differed from the statutory Federal income tax rate of 21.0%.  There were several items that increased the effective tax rate to 60.2% including the impacts of tax credits, return to accrual adjustments, and state taxes on the Federal rate. These increases were partially offset by a change in uncertain tax positions.

The effective tax rate for fiscal 2020 was 14.5%, which differed from the statutory Federal income tax rate of 21%. The minor items that lowered the effective tax rate primarily included the impacts of tax credits and state taxes on the Federal rate. These decreases were offset to a lesser degree by the recording of a partial valuation allowance for state taxes and minor return to accrual adjustments.

Adjusted EBITDA. Adjusted EBITDA was $34.1 million, or 5.0% of net sales, for fiscal 2021, a decrease of $20.6 million, or 37.6%, compared to $54.7 million, or 6.2% of net sales, for fiscal 2020. The decrease in Adjusted EBITDA was primarily the result of decreased revenues and gross profit, which was also unfavorably impacted by higher manufacturing costs, due to the COVID-19 pandemic. Additionally, there were decreases in operational transformation initiatives, interest expense, and depreciation, amortization, and disposals, which were partially offset by an increase in share-based compensation expense.

The following table sets forth a reconciliation of net (loss) income to Adjusted EBITDA for the fiscal years presented:

(1) Includes $0.3 million and $0.4 million for fiscal 2021 and 2020, respectively, representing interest expense on operating lease liabilities, which are a component of lease expense and presented as a single operating expense in selling, general and administrative expenses on our Consolidated Statements of Operations.

(2) Includes $0.8 million and $0.7 million for fiscal 2021 and 2020, respectively, representing amortization on right-of-use operating lease assets, which are a component of lease expense and presented as a single operating expense in selling, general and administrative expenses on our Consolidated Statements of Operations.

(3) Primarily costs incurred for third party cleaning services and personal protective equipment for our employees in response to the COVID-19 pandemic.

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Consolidated Results of Operations for the fiscal years ended October 3, 2020 and September 28, 2019:

The following provides the results of operations of Blue Bird's two reportable segments:

Net sales. Net sales were $879.2 million for fiscal 2020, a decrease of $139.7 million, or 13.7%, compared to $1.019 billion for fiscal 2019. The decrease in net sales was attributed to the COVID-19 pandemic which caused the unplanned and abrupt increase in remote learning arrangements and uncertainty in how school districts would administer schooling, resulting in decreased demand for school buses.

Bus sales decreased $129.6 million, or 13.6%, reflecting a decrease in units booked that was partially offset by slightly higher sales prices. In fiscal 2020, 8,878 units were booked compared to 11,017 units booked in fiscal 2019. The decrease in Bus revenue and volumes reflect the timing of orders being significantly impacted by COVID-19. The 7.2% increase in unit price for fiscal 2020 compared to fiscal 2019 mainly reflects the full-year impact of pricing actions taken in fiscal 2019 to partially offset commodity costs, as well as product and customer mix changes.

Parts sales decreased $10.0 million, or 15.0%, for fiscal 2020 compared to fiscal 2019, as we had lower sales volume, mainly from lower school bus units in operation due to school closures caused by the COVID-19 pandemic. Stay at home orders and school closures reduced bus repair and maintenance activities due to lower bus use.

Cost of goods sold. Total cost of goods sold was $783.0 million for fiscal 2020, a decrease of $102.4 million, or 11.6%, compared to $885.4 million for fiscal 2019. As a percentage of net sales, total cost of goods sold increased from 86.9% to 89.1%.

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Bus segment cost of goods sold decreased $95.7 million, or 11.4%, for fiscal 2020 compared to fiscal 2019 due to reduced sales volumes. The average cost of goods sold per unit for fiscal 2020 was 10.0% higher compared to the average cost of goods sold per unit for fiscal 2019 due to increases in manufacturing costs from several COVID-19 related factors including hourly workforce absenteeism and supply chain disruptions, each of which created manufacturing inefficiencies and higher costs.

The $6.7 million, or 15.5%, decrease in parts segment cost of goods sold for fiscal 2020 compared to fiscal 2019 aligned with the decrease in sales volume noted above.

Operating profit. Operating profit was $22.0 million for fiscal 2020, a decrease of $21.8 million, or 49.8%, compared to $43.8 million for fiscal 2019. Profitability was negatively impacted by a decrease of $37.3 million in gross profit, which was partially offset by a decrease of $15.4 million in selling, general and administrative expenses due in large part to several significant product development initiatives during fiscal 2019 as well as cost control measures implemented in fiscal 2020, as a response to the COVID-19 pandemic, including headcount reductions and lower travel-related expense.

Interest expense. Interest expense was $12.3 million for fiscal 2020, a decrease of $0.6 million, or 4.9%, compared to $12.9 million for fiscal 2019. The decrease was primarily attributed to lower interest rates and a lower average borrowing level on the term debt.

Income taxes. We recorded income tax expense of $1.5 million for fiscal 2020, compared to income tax expense of $7.6 million for fiscal 2019. The reduction in expense was primarily attributed to lower amounts of taxable income in fiscal 2020 due to the impacts of COVID-19 on our operations.

The effective tax rate for fiscal 2020 differed from the statutory Federal income tax rate of 21.0%. There were minor items that lowered the effective tax rate to 14.5%, primarily the impacts of tax credits and state taxes on the Federal rate. These decreases were offset to a lesser degree by the recording of a partial valuation allowance for state taxes and minor return to accrual adjustments.

The effective tax rate for fiscal 2019 was 25.6%, which differed from the statutory Federal income tax rate of 21.0%. The difference was mainly due to the unfavorable impact of valuation allowances, share-based and other compensation limitations, and state taxes, which included the application of tax credits claimed as offsets against our payroll tax liabilities. The valuation allowance increased mainly due to the accrual of income tax credits that were greater than our ability to utilize before expiration. These items were partially offset by benefits from federal and state tax credits.

Adjusted EBITDA. Adjusted EBITDA was $54.7 million, or 6.2% of net sales, for fiscal 2020, a decrease of $27.1 million, or 33.2%, compared to $81.8 million, or 8.0% of net sales, for fiscal 2019. The decrease in Adjusted EBITDA was primarily the result of decreased revenues and gross profit, which was also unfavorably impacted by higher manufacturing costs, due to the COVID-19 pandemic. The decrease was partially offset by lower selling, general and administrative expenses.

The following table sets forth a reconciliation of net income to Adjusted EBITDA for the fiscal years presented:

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(1) Includes $0.4 million for both fiscal 2020 and 2019, representing interest expense on operating lease liabilities, which are a component of lease expense and presented as a single operating expense in selling, general and administrative expenses on our Consolidated Statements of Operations.

(2) Includes $0.7 million for both fiscal 2020 and 2019, representing amortization on right-of-use operating lease assets, which are a component of lease expense and presented as a single operating expense in selling, general and administrative expenses on our Consolidated Statements of Operations.

(3) Primarily costs incurred for third party cleaning services and personal protective equipment for our employees in response to the COVID-19 pandemic.

Liquidity and Capital Resources

The Company's primary sources of liquidity are cash generated from operations, available cash, and borrowings under the Amended Credit Agreement (defined below). At October 2, 2021, the Company had $11.7 million of available cash and cash equivalents (net of outstanding checks) and $48.7 million of additional borrowings available under the Revolving Credit Facility (defined below). The Company’s revolving line of credit is available for working capital requirements, capital expenditures and other general corporate purposes. At October 2, 2021, the Company was in compliance with all covenants required by the Amended Credit Agreement.

Credit Agreement

On December 12, 2016 (the “Closing Date”), Blue Bird Body Company as the borrower ("Borrower"), a wholly-owned subsidiary of the Company, executed a $235.0 million five-year credit agreement with Bank of Montreal, which acts as the administrative agent and an issuing bank, Fifth Third Bank, as co-syndication agent and an issuing bank, and Regions Bank, as co-syndication agent, together with other lenders (the "Credit Agreement").

The credit facilities provided for under the Credit Agreement consisted of a term loan facility in an aggregate initial principal amount of $160.0 million (the “Term Loan Facility”) and a revolving credit facility with aggregate commitments of $75.0 million. The revolving credit facility included a $15.0 million letter of credit sub-facility and $5.0 million swingline sub-facility (the “Revolving Credit Facility,” and together with the Term Loan Facility, each a “Credit Facility” and collectively, the “Credit Facilities”). The borrowings under the Term Loan Facility, which were made at the Closing Date, may not be re-borrowed once they are repaid. The borrowings under the Revolving Credit Facility may be repaid and reborrowed from time to time at our election. The proceeds of the loans under the Credit Facilities that were borrowed on the Closing Date were used to finance in part, together with available cash on hand, (i) the repayment of certain existing indebtedness of the Company and its subsidiaries, and (ii) transaction costs associated with the consummation of the Credit Facilities.

The obligations under the Credit Agreement and the related loan documents (including without limitation, the borrowings under the Credit Facilities (including the Incremental Term Loan discussed below) and obligations in respect of certain cash management and hedging obligations owing to the agents, the lenders or their affiliates), are, in each case, secured by a lien on and security interest in substantially all of the assets of the Company and its subsidiaries (including the Borrower), with certain exclusions as set forth in a collateral agreement entered into on December 12, 2016.

Up to $75.0 million of additional term loans and/or revolving credit commitments may be incurred under the Credit Agreement, subject to certain limitations as set forth in the Credit Agreement, and which additional loans and/or commitments would require further commitments from the existing lenders or from new lenders.

The Credit Agreement contains negative and affirmative covenants affecting the Company and its subsidiaries including the Borrower, with certain exceptions set forth in the Credit Agreement. The negative covenants and restrictions include, among others: limitations on liens, dispositions of assets, consolidations and mergers, loans and investments, indebtedness, transactions with affiliates (including management fees and compensation), dividends, distributions and other restricted payments, change in fiscal year, fundamental changes, amendments to and subordinated indebtedness, restrictive agreements, sale and leaseback transactions and certain permitted acquisitions. Dividends, distributions, and other restricted payments are permitted in certain circumstances under the Credit Agreement, generally based upon our levels of excess Free Cash Flow and unrestricted cash (as defined in the Credit Agreement) and maintenance of specified TNLRs.

First Amended Credit Agreement

On September 13, 2018, the Company executed an amendment to the Credit Agreement (the "First Amended Credit Agreement"), by and among the Company, the Borrower, and Bank of Montreal, acting as administrative agent together with other lenders. The First Amended Credit Agreement provided for an aggregate lender commitment of $50.0 million in additional term loan borrowings (the

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“Incremental Term Loan”) that was intended to finance a portion of a tender offer up to $50.0 million, which transaction closed in October 2018.

After giving effect to the First Amended Credit Agreement, the initial $160.0 million Term Loan Facility, with a balance of $146.2 million at September 29, 2018, increased $50.0 million, and the initial $75.0 million Revolving Credit Facility increased $25.0 million. The amended Credit Facilities each mature on September 13, 2023, the fifth anniversary of the effective date of the First Amended Credit Agreement.

After giving effect to the First Amended Credit Agreement, the interest payable with respect to the Term Loan Facility was (i) from the first amendment effective date until the first quarter ended on or about September 30, 2018, LIBOR plus 2.25% and (ii) commencing with the fiscal quarter ended on or about September 30, 2018 and thereafter, dependent on the TNLR of the Company, an election of either base rate or LIBOR pursuant to the table below. The Company's TNLR is defined as the ratio of (a) consolidated net debt to (b) consolidated EBITDA, which is an adjusted EBITDA metric that could differ from Adjusted EBITDA appearing in the Company’s periodic filings on Form 10-K or Form 10-Q as the adjustments to the calculations are not uniform, at the end of each fiscal quarter for the consecutive four fiscal quarter period most recently then ending.

Under the First Amended Credit Agreement, the principal of the Term Loan Facility must be paid in quarterly installments on the last day of each fiscal quarter, in an amount equal to:

•$2,475,000 per quarter beginning on the last day of the Company’s first fiscal quarter of 2019 through the last day of the Company’s third fiscal quarter in 2021;

•$3,712,500 per quarter beginning on the last day of the Company’s fourth fiscal quarter in 2021 through the last day of the Company’s third fiscal quarter in 2022;

•$4,950,000 per quarter beginning on the last day of the Company’s fourth fiscal quarter in 2022 through the last day of the Company’s second fiscal quarter in 2023, with the remaining principal amount due at maturity.

There are customary events of default under the First Amended Credit Agreement, including, among other things, events of default resulting from (i) failure to pay obligations when due under the First Amended Credit Agreement, (ii) insolvency of the Company or its material subsidiaries, (iii) defaults under other material debt, (iv) judgments against the Company or its subsidiaries, (v) failure to comply with certain financial maintenance covenants (as set forth in the First Amended Credit Agreement), or (vi) a change of control of the Company, in each case subject to limitations and exceptions as set forth in the First Amended Credit Agreement.

The First Amended Credit Agreement contained customary covenants and warranties including, among other things, an amended TNLR financial maintenance covenant which required compliance as follows:

Second Amended Credit Agreement

On May 7, 2020, the Company entered into a second amendment to the Credit Agreement and First Amended Credit Agreement (the "Second Amended Credit Agreement"). The Second Amended Credit Agreement provided $41.9 million in additional revolving commitments bringing the total revolving commitments to $141.9 million. The revolving commitments under the Second Amended Credit Agreement mature on September 13, 2023, which is the fifth anniversary of the effective date of the First Amended Credit Agreement. The interest rate pricing grid remained unchanged, but the LIBOR floor was amended from 0% to 0.75%.

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Third Amended Credit Agreement

On December 4, 2020, the Company executed a third amendment to the Credit Agreement, First Amended Credit Agreement and Second Amended Credit Agreement (the "Third Amended Credit Agreement"). The Third Amended Credit Agreement, among other things, provided for certain temporary amendments to the Credit Agreement from the third amendment effective date through and including the first date on which (a)(i) a compliance certificate is timely delivered with respect to a fiscal quarter ending on or after March 31, 2022 demonstrating compliance with certain financial performance covenants for such fiscal quarter (the “Limited Availability Period”), or (ii) the Borrower elects to terminate the Limited Availability Period; and (b) the absence of a default or event of default.

Amendments to the financial performance covenants provided that during the Limited Availability Period, a higher maximum TNLR was permitted, and required the Company to maintain liquidity (in the form of undrawn availability under the Revolving Credit Facility and unrestricted cash and cash equivalents) of at least $15.0 million. For the duration between the fiscal quarter ended on or around December 31, 2020 and the fiscal quarter ended on or around September 30, 2021 that fell within the Limited Availability Period, a quarterly minimum consolidated EBITDA covenant applied instead of a maximum TNLR.

The pricing grid in the First Amended Credit Agreement, which is based on the ratio of the Company’s consolidated net debt to consolidated EBITDA, remained unchanged.  However, during the Limited Availability Period, an additional margin of 0.50% applied.

During the Limited Availability Period, the Third Amended Credit Agreement required that the Borrower prepay existing revolving loans and, if undrawn and unreimbursed letters of credit exceed $7.0 million, cash collateralize letters of credit if unrestricted cash and cash equivalents exceed $20.0 million, as determined on a semimonthly basis.  Any issuance, amendment, renewal, or extension of credit during the Limited Availability Period may not cause unrestricted cash and cash equivalents to exceed $20.0 million, or cause the aggregate outstanding Revolving Credit Facility principal to exceed $100.0 million. The Third Amended Credit Agreement also implemented a cap on permissible investments, restricted payments, certain payments of indebtedness and the fair market value of all assets subject to permitted dispositions during the Limited Availability Period.

For the duration of the Limited Availability Period, the Third Amended Credit Agreement sets forth additional monthly reporting requirements, and required subordination agreements and intercreditor arrangements for certain other indebtedness and liens subject to administrative agent approval.

Fourth Amended Credit Agreement

On November 24, 2021, the Company executed a fourth amendment to the Credit Agreement, First Amended Credit Agreement, Second Amended Credit Agreement and Third Amended Credit Agreement (the "Fourth Amended Credit Agreement" and collectively, the "Amended Credit Agreement"). The Fourth Amended Credit Agreement, among other things, provides for certain temporary amendments to the Credit Agreement from the third amendment effective date through and including (a) April 1, 2023 (the “Amended Limited Availability Period”), or (b) the first date on which Borrower elects to terminate the Amended Limited Availability Period, in each case, subject to (x) the absence of a default or event of default and (y) pro forma compliance with the financial covenant performance covenants under the Amended Credit Agreement.

With respect to the financial performance covenants, during the Amended Limited Availability Period for the fiscal quarters ending January 1, 2022 through October 1, 2022, the TNLR requirement is not applicable, although it continues to impact the interest rate that is charged on outstanding borrowings as discussed below. Instead, the minimum consolidated EBITDA that the Company is required to maintain during the Amended Limited Availability Period has been updated to include fiscal 2022 as set forth in the table below (in millions):

However, in the event that Borrower elects to terminate the Amended Limited Availability Period in fiscal 2022, the maximum TNLR permitted is 3.50x.

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The minimum liquidity (in the form of undrawn availability under the Revolving Credit Facility and unrestricted cash and cash equivalents) that the Company must maintain during the Amended Limited Availability Period has been amended as set forth in the table below (in millions):

Additionally, a new financial performance covenant was added to the Amended Credit Agreement, requiring that school bus units manufactured by the Company (“Units”) not fall below the pre-set thresholds set forth in the table below on a three month trailing basis (“Units Covenant”). The Units Covenant is triggered only if the Company’s liquidity for the most-recently ended fiscal month is less than $50.0 million during the Amended Limited Availability Period:

If the Units during any three fiscal month period set forth above is less than the minimum required by the Units Covenant, Borrower may elect to carry forward up to 50% of certain applicable excess Units to satisfy the Units Covenant requirement. However, Borrower may not make such election in two consecutive three fiscal month periods.

The pricing grid in the Amended Credit Agreement, which is based on the TNLR, is determined in accordance with the amended pricing matrix set forth below:

During the Amended Limited Availability Period (notwithstanding the pricing grid set forth above), the applicable rate shall be (a) solely to the extent that the aggregate revolving exposures exceed $100.0 million, 5.75% with respect to such excess and (b) with respect to all other revolving exposures, the sum of the rate determined by the administrative agent in accordance with the pricing grid set forth above, plus 0.50%.

Additional allowances have been made in the Fourth Amended Credit Agreement for the Company to issue or incur up to $100.0 million of qualified equity interests issued by the Company, unsecured subordinated indebtedness or unsecured convertible indebtedness (collectively, “Junior Capital”). Upon the issuance or incurrence of any Junior Capital, the Company is required to

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prepay the outstanding revolving loans (with no permanent reduction in the revolving commitments) in an amount equal to the lesser of (a) 100% of the net proceeds from such Junior Capital and (b) the aggregate of revolving exposures then outstanding. Prior to the initial issuance or incurrence of any Junior Capital, any issuance, amendment, renewal, or extension of credit during the Amended Limited Availability Period may not cause the aggregate outstanding Revolving Credit Facility principal to exceed $110.0 million (“Availability Cap”). Following any issuance or incurrence of Junior Capital, the Availability Cap is permanently reduced to $100.0 million.

For the duration of the Amended Limited Availability Period, the Fourth Amended Credit Agreement sets forth additional monthly reporting requirements in connection with the manufactured school bus units required by the financial performance covenants, when applicable.

Short-Term and Long-Term Liquidity Requirements

Our ability to make principal and interest payments on borrowings under our Credit Facilities and our ability to fund planned capital expenditures will depend on our ability to generate cash in the future, which, to a certain extent, is subject to general economic, financial, competitive, regulatory and other conditions. The continuing adverse impacts from the COVID-19 pandemic materially impacted our fiscal 2021 results, causing lower customer orders for both buses and parts, significant supply chain disruptions, and higher rates of absenteeism among our hourly production workforce. The continuing development and fluidity of the pandemic precludes any prediction as to the ultimate severity of the adverse impacts on our business, financial condition, results of operations, and liquidity. See PART I, Item 1A. "Risk Factors," of this Report for a discussion of the material risks we believe we face particularly related to the COVID-19 pandemic.

The pandemic could cause a severe contraction in our profits and/or liquidity which could lead to issues complying with our Amended Credit Agreement covenants. Our primary financial covenants are (i) for fiscal 2022, minimum consolidated EBITDA, which is an adjusted EBITDA metric that could differ from Adjusted EBITDA appearing in the Company’s periodic filings on Form 10-K or Form 10-Q as the adjustments to the calculations are not uniform, at the end of each fiscal quarter for the consecutive four fiscal quarter period most recently then ending; (ii) for fiscal 2022 and through April 1, 2023, minimum liquidity at the end of each fiscal month; (iii) when applicable during fiscal 2022, minimum school bus units manufactured calculated on a three month trailing basis at the end of each fiscal month; and (iv) beginning in fiscal 2023 and thereafter, TNLR, defined as the ratio of (a) consolidated net debt to (b) consolidated EBITDA. If we are not able to comply with such covenants, we may need to seek additional covenant relief or even refinance the debt to a "covenant light" or "no covenant" structure. We cannot assure our investors that we would be successful in amending or refinancing our existing debt. An amendment or refinancing of our existing debt could lead to higher interest rates and possible up-front expenses than included in our historical financial statements.

On December 15, 2021, we issued and sold through a private placement an aggregate 4,687,500 shares of our common stock at $16.00 per share. The $75.0 million of net proceeds that we received from this transaction may be used for working capital and other general corporate purposes, which may include acquisitions, investments in technologies or businesses, operating expenses and capital expenditures. Refer to Note 19, Subsequent Events, to the Company’s consolidated financial statements for additional information regarding this transaction.

To increase our liquidity in future periods, we could pursue raising additional capital via an equity or debt offering as we filed a Registration Statement on Form S-3 with the SEC in November 2021. However, we cannot assure our investors that we would be successful in raising this additional capital, which could also lead to increased expense and larger up-front fees when compared with our historical financial statements.

Seasonality

Historically, our business has been highly seasonal with school districts buying their new school buses so that they will be available for use on the first day of the school year, typically in mid-August to early September. This has resulted in our third and fourth fiscal quarters representing our two busiest quarters from a sales and production perspective, the latter ending on the Saturday closest to September 30. Our quarterly results of operations, cash flows, and liquidity have been and are likely to be impacted by the seasonal patterns. Working capital has historically been a significant use of cash during the first fiscal quarter due to planned shutdowns and a significant source of cash generation in the fourth fiscal quarter. With the COVID-19 pandemic impact on school systems and the uncertainty regarding (i) in-person schooling schedules and duration and (ii) the severity and duration of ongoing supply chain constraints, seasonality and working capital trends have become unpredictable. Seasonality and variations from historical seasonality have impacted the comparison of working capital and liquidity results between fiscal periods.

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Cash Flows

The following table sets forth general information derived from our statement of cash flows for the fiscal years presented:

Total cash (used in) provided by operating activities

Cash flows used in operating activities totaled $(54.2) million for fiscal 2021, as compared with $3.5 million of cash flows provided by operating activities for fiscal 2020. The primary drivers of the $57.7 million decrease were the following:

•A year over year reduction of $12.5 million in net income.

•The effect of net changes in operating assets and liabilities negatively impacted fiscal 2021 operating cash flows by $47.1 million compared to fiscal 2020. The primary drivers in this category were the unfavorable changes in inventory, accounts receivable, and other assets of $91.0 million, $5.3 million, and $5.5 million, respectively. These unfavorable changes were partially offset by favorable changes in accounts payable of $54.3 million. The significant increase in the inventory balance at the end of fiscal 2021 when compared with the end of fiscal 2020 (net use of cash) primarily resulted from our inability to build and sell buses during the fourth fiscal quarter of fiscal 2021 due to shortages of certain critical components. Because we were still receiving other parts that were not in short supply that we were unable to utilize in our production process, we accumulated a significant amount of inventory at the end of fiscal 2021 that also resulted in a significant, but smaller, increase in the accounts payable balance at the end of fiscal 2021 when compared with fiscal 2020 (net source of cash).

•The impact of non-cash items (net source of cash) was $1.8 million higher in fiscal 2021 compared to fiscal 2020. Non-cash items impact net income or loss but do not have direct cash flows associated with them. The significant differences relate to the impact of higher amounts of share-based compensation of $1.8 million and lower equity in net income of non-consolidated affiliate of $2.7 million in fiscal 2021 compared to fiscal 2020. These changes were partially offset by decreases in depreciation and amortization expense of $1.0 million, non-cash interest of $0.9 million, and deferred taxes of $1.0 million in fiscal 2021 compared to fiscal 2020.

Cash flows provided by operating activities totaled $3.5 million and $55.7 million for fiscal 2020 and fiscal 2019, respectively. The primary drivers of the $52.2 million decrease were the following:

•A year over year reduction of $12.1 million in net income.

•The effect of net changes in operating assets and liabilities negatively impacted fiscal 2020 operating cash flow by $35.0 million compared to fiscal 2019. The primary drivers in this category were the unfavorable changes in accounts payable and accrued expenses of $75.7 million as well as accounts receivable of $10.6 million, which were partially offset by improvements in inventory level changes of $43.8 million and other assets of $9.7 million.

•The impact of non-cash items (net source of cash) was $5.1 million higher in fiscal 2019 compared to fiscal 2020. Non-cash items impact net income or loss but do not have direct cash flows associated with them. The significant differences relate to the impact of higher amounts of deferred taxes of $6.6 million, share-based compensation of $0.1 million, and pension amortization expense of $1.0 million in fiscal 2019 compared to fiscal 2020. These changes were partially offset by an increase in depreciation and amortization expense in fiscal 2020 of $4.0 million.

Total cash used in investing activities

Cash flows used in investing activities totaled $11.3 million and $18.8 million for fiscal 2021 and fiscal 2020, respectively. The $7.5 million decrease in cash used was primarily due to decreased spending on fixed assets in fiscal 2021 as compared to fiscal 2020.

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Cash flows used in investing activities totaled $18.8 million and $35.5 million for fiscal 2020 and fiscal 2019, respectively. The $16.7 million decrease in cash used was primarily due to decreased spending on manufacturing assets associated with our paint facility in fiscal 2020 when compared to fiscal 2019.

Total cash provided by (used in) financing activities

Cash provided by financing activities totaled $32.8 million for fiscal 2021, as compared with $11.1 million of cash used in financing activities for fiscal 2020. In fiscal 2021, net borrowings under the revolving credit facility increased $45.0 million compared to fiscal 2020. This source of cash was partially offset by increased cash paid for debt costs of $1.5 million in fiscal 2021 as compared to fiscal 2020.

Cash used in financing activities totaled $11.1 million and $9.5 million for fiscal 2020 and fiscal 2019, respectively. In fiscal 2020 we used more cash compared to the prior year on finance lease payments totaling $0.8 million, debt issuance costs totaling $0.9 million, and payments of employee taxes for share-based compensation activity totaling $2.9 million. These increased cash outflows were partially offset by approximately $2.7 million more in cash received for warrant exercises in fiscal 2020 when compared with fiscal 2019. All warrants have expired or been exercised so this component of cash flows from financing activities is not expected to repeat in future years.

Free cash flow

Management believes the non-GAAP measurement of Free Cash Flow, defined as net cash used in or provided by operating activities less cash paid for fixed assets and acquired intangible assets, fairly represents the Company’s ability to generate surplus cash that could fund activities not in the ordinary course of business. See “Key Measures We Use to Evaluate Our Performance” for further discussion. The following table sets forth the calculation of Free Cash Flow for the fiscal years presented:

Free Cash Flow for fiscal 2021 was $50.9 million lower than Free Cash Flow for fiscal 2020, primarily due to a $57.7 million decrease in cash provided by operating activities as discussed above. This decrease was partially offset by a reduction of $6.8 million in cash paid for fixed assets in fiscal 2021 as compared to fiscal 2020 as we limited capital expenditures in fiscal 2021 to mitigate the ongoing impact of the COVID-19 pandemic on our operations, financial results and cash flows.

Free Cash Flow for fiscal 2020 was $35.7 million lower than Free Cash Flow for fiscal 2019, primarily due to a $52.2 million decrease in cash provided by operating activities as discussed above. This decrease was partially offset by a reduction of $16.5 million in cash paid for fixed assets as we limited capital expenditures in fiscal 2020 and had significant capital expenditures related to our paint facility in fiscal 2019 that did not recur.

Off-Balance Sheet arrangements

We had outstanding letters of credit totaling $6.3 million at October 2, 2021, the majority of which secure our self-insured workers compensation program, the collateral for which is regulated by the State of Georgia.

We had a $3.0 million guarantee outstanding at October 2, 2021 which relates to a guarantee of indebtedness for a term loan obtained by one of our dealers with a remaining maturity up to 1.3 years. The $3.0 million represents the estimated maximum amount we would be required to pay upon default of all guaranteed indebtedness, and we believe the likelihood of required performance to be remote.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions. At the date of the financial statements, these estimates and assumptions affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities, and during the reporting period, these estimates and assumptions affect the reported amounts of revenues and expenses. For example, significant management judgments are required in determining excess, obsolete, or unsalable inventory; allowance for doubtful accounts; potential impairment of long-lived assets, goodwill and intangibles; and the accounting for self-insurance reserves, warranty reserves, pension obligations, income taxes, environmental liabilities and contingencies. Future events and their effects cannot be predicted with certainty, and, accordingly, the Company’s accounting

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estimates require the exercise of judgment. The accounting estimates used in the preparation of the Company’s consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as the Company’s operating environment changes. The Company evaluates and updates its assumptions and estimates on an ongoing basis, based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, and may employ outside experts to assist in the Company’s evaluations. Actual results could differ from the estimates that the Company has used.

The estimates that require management to exercise the greatest extent of judgment in establishing assumptions and that could have a material impact on our consolidated financial statements should they change significantly in a future period are defined as "critical" in nature and include the following:

Self-Insurance Reserves

The Company is self-insured for the majority of its workers’ compensation and medical claims. The expected ultimate cost for claims incurred as of the balance sheet date is not discounted and is recognized as a liability. Self-insurance losses for claims filed and claims incurred but not reported are accrued based upon estimates of the aggregate liability for uninsured claims using loss development factors and actuarial assumptions followed in the insurance industry and historical loss development experience. The establishment of the reserves utilizing such estimates and assumptions is based on the premise that historical claims experience is indicative of current or future expected activity, which could differ significantly. At October 2, 2021 and October 3, 2020, reserves totaled approximately $4.5 million and $5.0 million, respectively.

Goodwill and Intangible Assets

Goodwill represents the excess of the purchase price of acquired businesses over the fair value of the assets acquired less liabilities assumed in connection with such acquisition. In accordance with the provisions of Accounting Standards Codification ("ASC") 350, Intangibles—Goodwill and Other (“ASC 350”), goodwill and intangible assets with indefinite useful lives acquired in an acquisition are not amortized, but instead are tested for impairment at least annually or more frequently should an event occur or circumstances indicate that the carrying amount may be impaired. Such events or circumstances may be a significant change in business climate, economic and industry trends, legal factors, negative operating performance indicators, significant competition, changes in strategy or disposition of a reporting unit or a portion thereof. Although management believes the assumptions used in the determination of the value of the enterprise are reasonable, no assurance can be given that these assumptions will be achieved. As a result, impairment charges may occur when goodwill and intangible assets with indefinite useful lives are tested for impairment in the future.

We have two reporting units for which we test goodwill for impairment: Bus and Parts. In the evaluation of goodwill for impairment, we have the option to perform a qualitative assessment to determine whether further impairment testing is necessary or to perform a quantitative assessment by comparing the fair value of a reporting unit to its carrying amount, including goodwill. Under the qualitative assessment, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. If under the quantitative assessment the fair value of a reporting unit is less than its carrying amount, then the amount of the impairment loss, if any, must be measured under step two of the impairment analysis. In step two of the analysis, we would record an impairment loss equal to the excess of the carrying value of the reporting unit’s goodwill over its implied fair value should such a circumstance arise.

Fair value of the reporting units is estimated primarily using the income approach, which incorporates the use of discounted cash flow ("DCF") analysis. A number of significant assumptions and estimates are involved in the application of the DCF model to forecast operating cash flows, including markets and market shares, sales volumes and prices, costs to produce, tax rates, capital spending, discount rate and working capital changes. The cash flow forecasts are based on approved strategic operating plans.

During the fourth quarter of each fiscal year presented, we performed our annual impairment assessment of goodwill which did not indicate that an impairment existed.

In the evaluation of indefinite lived assets for impairment, we have the option to perform a qualitative assessment to determine whether further impairment testing is necessary, or to perform a quantitative assessment by comparing the fair value of an asset to its carrying amount. The Company’s intangible asset with an indefinite useful life is the Blue Bird trade-name. Under the qualitative assessment, an entity is not required to calculate the fair value of the asset unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. If a qualitative assessment is not performed or if a quantitative assessment is otherwise required, then the entity compares the fair value of an asset to its carrying amount and the amount of the impairment loss, if any, is the difference between fair value and carrying value. The fair value of our trade name is derived by using the relief from royalty method, which discounts the estimated cash savings we realize by owning the name instead of otherwise having to license or lease it.

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During the fourth quarter of each fiscal year presented, we performed our annual impairment assessment of our trade name which did not indicate that an impairment existed.

Our intangible assets with definite useful lives include customer relationships and engineering designs, which are amortized over their estimated useful lives of 2, 7, or 20 years using the straight-line method. These assets are tested for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable. No impairments have been recorded.

Pensions

We have pension benefit costs and obligations, which are developed from actuarial valuations. Actuarial assumptions attempt to anticipate future events and are used in calculating the expense and liability relating to our plan. These factors include assumptions we make about interest rates and expected investment return on plan assets. In addition, our actuarial consultants also use subjective factors such as mortality rates to develop our valuations. We review and update these assumptions on an annual basis at the beginning of each fiscal year. We are required to consider current market conditions, including changes in interest rates, in making these assumptions. Effective January 1, 2006, the benefit plan was frozen to all participants. No accrual of future benefits is earned or calculated beyond this date. Accordingly, our obligation estimate is based on benefits earned at that time discounted using an estimate of the single equivalent discount rate determined by matching the plan’s future expected cash flows to spot rates from a yield curve comprised of high-quality corporate bond rates of various durations. The expected long-term rate of return on plan assets reflects the average rate of earnings expected on the funds invested, or to be invested, to provide for the pension benefit obligation. In estimating that rate, appropriate consideration is given to the returns being earned by the plan assets in the fund and rates of return expected to be available for reinvestment and we consider asset allocations, input from an external pension investment adviser, and risks and other factors adjusted for our specific investment strategy. The focus is on long-term trends and provides for the consideration of recent plan performance.

The actuarial assumptions that we use may differ materially from actual results due to changing market and economic conditions as well as longer or shorter life spans of participants. These differences may result in a significant impact to the measurement of our pension benefit obligations, and to the amount of pension benefits expense we may record. For example, at October 2, 2021, a one-half percent increase in the discount rate would reduce the projected benefit obligation of our pension plans by approximately $9.1 million, while a one-half percent decrease in the discount rate would increase the projected benefit obligation of our pension plans by approximately $10.1 million.

Product Warranty Costs

The Company’s products are generally warranted against defects in material and workmanship for a period of one to five years. A provision for estimated warranty costs is recorded at the time a unit is sold. The methodology to determine the warranty reserve calculates the average expected future warranty claims using historical warranty claims by body type, by month, over the life of the bus, which is then multiplied by remaining months under warranty, by warranty type. The establishment of the reserve utilizing such estimates and assumptions is based on the premise that historical claims experience, both in terms of the volume of claims activity and related cost, is indicative of future expected claims activity. Management believes the methodology is reasonable (i) since the Company's product offerings and manufacturing processes do not change quickly or significantly and (ii) given the significant investments that the Company has made, and expects to continue making, to improve the quality, reliability and safety of the school buses it manufactures. Accordingly, while management believes that this methodology provides an accurate reserve estimate, actual claims incurred could differ from the original estimates, requiring future adjustments.

Income Taxes

The Company accounts for income taxes in accordance with ASC 740, Income Taxes (“ASC 740”), which requires an asset and liability approach to financial accounting and reporting for income taxes. Under this approach, deferred income taxes represent the expected future tax consequences of temporary differences between the financial statement and tax basis of assets and liabilities. The Company evaluates its ability, based on the weight of evidence available, to realize future tax benefits from deferred tax assets and establishes a valuation allowance to reduce a deferred tax asset to a level which, more likely than not, will be realized in future years.

The Company recognizes uncertain tax positions based on a cumulative probability assessment if it is more likely than not that the tax position will be sustained upon examination by an appropriate tax authority with full knowledge of all information. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Amounts recorded for uncertain tax positions are periodically assessed, including the evaluation of new facts and circumstances, to ensure sustainability of the positions. The Company records interest and penalties related to unrecognized tax benefits in income tax expense.

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Recent Accounting Pronouncements

A discussion of recently issued accounting standards applicable to the Company is described in Note 2, Summary of Significant Accounting Policies and Recently Issued Accounting Standards, in the Notes to Consolidated Financial Statements contained elsewhere in this Report, and we incorporate such discussion by reference herein.