J&J SNACK FOODS CORP (JJSF) FY 2023 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
Objective
This 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 our management regarding our financial condition and results of operations, liquidity and certain other factors that may affect our future results. The following discussion should be read in conjunction with the consolidated financial statements and accompanying notes included in Item 8 of this Form 10-K. Refer to the Company’s Annual Report on Form 10-K for the fiscal year ended September 24, 2022 for additional information related to the discussion and analysis of our financial condition and results of operations for the fiscal year ended September 24, 2022 compared to the fiscal year ended September 25, 2021.
16
Business Overview
The Company manufactures snack foods and distributes frozen beverages which it markets nationally to the foodservice and retail supermarket industries. The Company’s principal snack food products are soft pretzels, frozen novelties, churros and bakery products. We are the largest manufacturer of soft pretzels in the United States. Other snack food products include funnel cake and handheld products. The Company’s principal frozen beverage products are the ICEE brand frozen carbonated beverage and the SLUSH PUPPIE brand frozen non-carbonated beverage.
The Company’s Food Service and Frozen Beverages sales are made primarily to foodservice customers including snack bar and food stand locations in leading chain, department, discount, warehouse club and convenience stores; malls and shopping centers; fast food and casual dining restaurants; stadiums and sports arenas; leisure and theme parks; movie theatres; independent retailers; and schools, colleges and other institutions. The Company’s retail supermarket customers are primarily supermarket chains.
Business Trends
COVID-19
Dating back to the onset of the COVID-19 pandemic in fiscal 2020, the effects of COVID-19 on consumer behavior have impacted the relevant demand for our Food Service, Retail, and Frozen Beverage segments. In fiscal 2020, we saw a shift in demand towards increased at-home food consumption, which benefited our Retail segment, and away from in-restaurant dining, and experience driven activities, which negatively impacted our Food Service and Frozen Beverage segments. This shift in demand proved inconsistent and volatile over the course of the pandemic. In fiscal 2021 and fiscal 2022, as part of the pandemic economy that impacted our operations opened, sales in our Food Service and Frozen Beverages segments improved.
The aforementioned shift, and overall volatility in demand, has had a significant impact on the operating results of each of our three segments over the past three fiscal years. Additional impacts from the pandemic have caused us to experience higher hourly wage rates paid to our front-line employees, increased costs for personal protective equipment, increased complexity and uncertainty around production planning and forecasting, and overall lower levels of efficiency in our production and distribution network, all of which has unfavorably impacted our operating results. In fiscal 2023, our operating environment became more predictable and stable, and the majority of the volatility and shifts in demand that had been more present in fiscal 2021 and 2022, somewhat subsided.
Inflation
We continued to experience cost inflation through fiscal 2023, although the impact was significantly less than it had been in fiscal 2022, primarily tied to a smaller group of raw materials and packaging, and materially offset by the benefit of the pricing actions that had been taken in fiscal 2022. The inflationary cost environment we experienced during fiscal 2022 resulted in significantly higher input costs for our business. During fiscal 2022, we experienced unprecedented inflationary pressures on commodities such as flour, oils, eggs, meats and dairy, in addition to notably higher costs for packaging, freight and warehousing, and labor. To help offset these cost headwinds, we implemented a series of pricing actions throughout fiscal 2022.
Fiscal Period
The Company’s fiscal year is the 52- or 53- week period that ends on the last Saturday of September. An additional week is included in the last fiscal quarter every five or six years to realign the Company’s fiscal quarters with calendar quarters, which occurred in the Company’s fourth quarter of fiscal 2023. The Company’s fiscal year 2023 spanned 53 weeks, whereas fiscal years 2022 and 2021 spanned 52 weeks each.
17
RESULTS OF OPERATIONS:
Fiscal Year 2023 (53 weeks) Compared to Fiscal Year 2022 (52 weeks)
Results of Consolidated Operations
The following discussion provides a review of results for the fiscal year ended September 30, 2023 as compared with the fiscal year ended September 24, 2022.
| Summary of Results | Fiscal year ended | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, | September 24, | |||||||||||
| 2023 | 2022 | |||||||||||
| (53 weeks) | (52 weeks) | % Change | ||||||||||
| (in thousands) | ||||||||||||
| Net Sales | $ | 1,558,829 | $ | 1,380,656 | 12.9 | % | ||||||
| Cost of goods sold | 1,088,964 | 1,011,014 | 7.7 | % | ||||||||
| Gross Profit | 469,865 | 369,642 | 27.1 | % | ||||||||
| Operating expenses | ||||||||||||
| Marketing | 110,258 | 91,636 | 20.3 | % | ||||||||
| Distribution | 172,804 | 159,637 | 8.2 | % | ||||||||
| Administrative | 75,425 | 55,189 | 36.7 | % | ||||||||
| Intangible asset impairment charges | 1,678 | 1,010 | ||||||||||
| Other general expense | 182 | 371 | (50.9 | )% | ||||||||
| Total Operating Expenses | 360,347 | 307,843 | 17.1 | % | ||||||||
| Operating Income | 109,518 | 61,799 | 77.2 | % | ||||||||
| Other income (expense) | ||||||||||||
| Investment income | 2,743 | 980 | 179.9 | % | ||||||||
| Interest expense | (4,747 | ) | (1,025 | ) | 363.1 | % | ||||||
| Earnings before income taxes | 107,514 | 61,754 | 74.1 | % | ||||||||
| Income tax expense | 28,608 | 14,519 | 97.0 | % | ||||||||
| NET EARNINGS | $ | 78,906 | $ | 47,235 | 67.0 | % |
| Comparisons as a Percentage of Net Sales | Fiscal year ended | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, | September 24, | |||||||||||
| 2023 | 2022 | Basis Pt Chg | ||||||||||
| Gross profit | 30.1 | % | 26.8 | % | 330 | |||||||
| Marketing | 7.1 | % | 6.6 | % | 50 | |||||||
| Distribution | 11.1 | % | 11.6 | % | (50 | ) | ||||||
| Administrative | 4.8 | % | 4.0 | % | 80 | |||||||
| Operating income | 7.0 | % | 4.5 | % | 250 | |||||||
| Earnings before income taxes | 6.9 | % | 4.5 | % | 240 | |||||||
| Net earnings | 5.1 | % | 3.4 | % | 170 |
18
NET SALES
Net sales increased by $178.2 million, or 13%, to $1,558.8 million in fiscal 2023. Fiscal 2023 net sales include $96.0 million of net sales from Dippin’ Dots, an increase of $62.2 million from prior fiscal year with the increase primarily attributable to the timing of the acquisition in prior year results. Organic sales growth was driven by growth across all three of the Company’s business segments, led by our core products including soft pretzels, churros, frozen novelties and frozen beverages. The organic sales growth was largely driven by improved marketing, new customers, additional product placement, as well as the benefit of our pricing actions that had been taken throughout fiscal 2022. To a lesser extent, fiscal 2023 net sales were benefited by the extra week in the fiscal year.
GROSS PROFIT
Gross profit increased by $100.2 million, or 27%, to $469.9 million in fiscal 2023. Gross profit as a percentage of sales increased to 30.1% in fiscal 2023 from 26.8% in fiscal 2022. The increase in gross profit as a percentage of sales was driven by enhanced production efficiencies and the benefit of our fiscal 2022 pricing actions and a better product mix, along with the stabilization of inflationary pressures on the back of historic highs in fiscal 2022. The cost of key ingredients including flour, oils, dairy and meats either declined, or remained materially flat, though double-digit increases were seen in sugar/sweeteners and mixes, which continued to negatively impact margins on certain products including frozen novelties and churros.
OPERATING EXPENSES
Total operating expenses increased by $52.5 million, or 17%, to $360.3 million in fiscal 2023 and increased as a percentage of sales to 23.1% in fiscal 2023 compared with 22.3% in fiscal 2022. The increase reflects the impact of inflationary pressures across the majority of our cost line items including industry-wide freight and distribution cost increases and wage increases that more heavily impacted the Company’s comparative results in the first and second fiscal quarters, offset somewhat by the benefits seen from our strategic initiatives to improve logistics management and increase efficiency across our distribution network and supply chain. The increase also reflects the full year impact of a higher expense Dippin’ Dots business in fiscal 2023 results.
Operating expenses included intangible asset impairment charges of $1.7 million in fiscal 2023 and $1.0 million in fiscal 2022. As a percentage of sales, marketing and selling expenses as a percentage of sales increased from 6.6% in fiscal 2022 to 7.1% in fiscal 2023, with the increase driven by the additional investment in marketing spend associated with new product launches and the promotion of our core brands. Distribution expenses as a percentage of sales decreased to 11.1% in fiscal 2023 from 11.6% in fiscal 2022, with the decrease driven by the benefits of our strategic initiatives to improve logistics management and increase efficiency across our distribution network and supply chain. Administrative expenses as a percentage of sales increased from 4.0% in fiscal 2022 to 4.8% in fiscal 2023, with the increase largely attributable to higher performance-based bonus payments and continued investments in capability.
OTHER INCOME AND EXPENSE
Investment income increased by $1.8 million, or 180%, to $2.7 million in fiscal 2023 due to the improving interest rate environment in fiscal 2023.
Interest expense increased by $3.7 million, or 363%, to $4.7 million in fiscal 2023 due to the Company’s outstanding borrowings under the Amended Credit Agreement.
INCOME TAX EXPENSE
Our effective tax rate in fiscal 2023 was 26.6%. Our effective tax rate in fiscal 2022 year was 23.5%.
NET EARNINGS
Net earnings increased $31.7 million, or 67%, in fiscal 2023 to $78.9 million, or $4.08 per diluted share, from $47.2 million or $2.46 per diluted share, in fiscal 2022 as a result of the aforementioned items.
There are many factors which can impact our net earnings from year to year, among which are the supply and cost of raw materials and labor, insurance costs, factors impacting sales as noted above, the continuing consolidation of our customers, our ability to manage our manufacturing, marketing and distribution activities, our ability to make and integrate acquisitions and changes in tax laws and interest rates.
Results of Operations - Segments
We have three reportable segments, as disclosed in the accompanying notes to the consolidated financial statements: Food Service, Retail Supermarkets and Frozen Beverages.
The Chief Operating Decision Maker for Food Service, Retail Supermarkets and Frozen Beverages reviews monthly detailed operating income statements and sales reports in order to assess performance and allocate resources to each individual segment. Sales and operating income are the key variables monitored by the Chief Operating Decision Maker and management when determining each segment’s and the Company’s financial condition and operating performance. In addition, the Chief Operating Decision Maker reviews and evaluates depreciation, capital spending and assets of each segment on a quarterly basis to monitor cash flow and asset needs of each segment.
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The following table is a summary of sales and operating income, which is how we measure segment profit.
| Fiscal year ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, | September 24, | |||||||||||
| 2023 | 2022 | |||||||||||
| (53 weeks) | (52 weeks) | % Change | ||||||||||
| (in thousands) | ||||||||||||
| Net Sales | ||||||||||||
| Food Service | $ | 981,840 | $ | 872,687 | 12.5 | % | ||||||
| Retail Supermarket | 215,428 | 197,943 | 8.8 | % | ||||||||
| Frozen Beverages | 361,561 | 310,026 | 16.6 | % | ||||||||
| Total Sales | $ | 1,558,829 | $ | 1,380,656 | 12.9 | % |
| Fiscal year ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, | September 24, | |||||||||||
| 2023 | 2022 | |||||||||||
| (53 weeks) | (52 weeks) | % Change | ||||||||||
| (in thousands) | ||||||||||||
| Operating Income | ||||||||||||
| Food Service | $ | 49,778 | $ | 18,512 | 168.9 | % | ||||||
| Retail Supermarket | 9,375 | 9,487 | (1.2 | )% | ||||||||
| Frozen Beverages | 50,365 | 33,800 | 49.0 | % | ||||||||
| Total Operating Income | $ | 109,518 | $ | 61,799 | 77.2 | % |
FOOD SERVICE SEGMENT RESULTS
| Fiscal year ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, | September 24, | |||||||||||
| 2023 | 2022 | |||||||||||
| (53 weeks) | (52 weeks) | % Change | ||||||||||
| (in thousands) | ||||||||||||
| Food Service Sales to External Customers | ||||||||||||
| Soft pretzels | $ | 235,572 | $ | 205,752 | 14.5 | % | ||||||
| Frozen novelties | 145,425 | 78,183 | 86.0 | % | ||||||||
| Churros | 108,927 | 88,242 | 23.4 | % | ||||||||
| Handhelds | 82,292 | 92,130 | (10.7 | )% | ||||||||
| Bakery | 378,149 | 381,526 | (0.9 | )% | ||||||||
| Other | 31,475 | 26,854 | 17.2 | % | ||||||||
| Total Food Service | $ | 981,840 | $ | 872,687 | 12.5 | % | ||||||
| Food Service Operating Income | $ | 49,778 | $ | 18,512 | 168.9 | % |
Sales to food service customers increased $109.2 million, or 13%, to $981.8 million in fiscal 2023, which included an increase of $62.2 million in sales from Dippin’ Dots. Soft pretzel sales to the food service market increased 14% to $235.6 million for the year, led by the continued increase in sales of our core pretzel products. Frozen novelties sales increased $67.2 million, or 86%, to $145.4 million for the year, with the increase largely driven by incremental Dippin’ Dots sales during fiscal 2023. Churro sales to food service customers were up 23% to $108.9 million for the year led by customer expansion and growing menu penetration. Sales of bakery products decreased $3.4 million, or 1%, to $378.1 million for the year, with the decrease attributable to the rationalization of certain lower margin Stock Keeping Units (“SKU”)’s. Handheld sales to food service customers decreased 11% to $82.3 million in fiscal 2023, with the decrease largely attributable to pricing declines related to the contractual pricing true-up of costing on certain raw material ingredients, as well as some volume declines amongst certain customers in the product category. Sales of funnel cake increased $4.6 million, or 17%, to $31.5 million.
Sales of new products in the first twelve months since their introduction were approximately $0.3 million for the fiscal year. The benefit of the wrap of prior year price increases favorably impacted sales in the fiscal year, and more than offset some volume declines seen in certain product categories.
Operating income in our Food Service segment increased from $18.5 million in fiscal 2022 to $49.8 million in fiscal 2023, largely driven by the benefit seen from the incremental Dippin’ Dots sales, as well as by improved gross margin performance and improving distribution expenses.
20
RETAIL SUPERMARKETS SEGMENT RESULTS
| Fiscal year ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, | September 24, | |||||||||||
| 2023 | 2022 | |||||||||||
| (53 weeks) | (52 weeks) | % Change | ||||||||||
| (in thousands) | ||||||||||||
| Retail Supermarket Sales to External Customers | ||||||||||||
| Soft pretzels | $ | 60,272 | $ | 61,925 | (2.7 | )% | ||||||
| Frozen novelties | 115,807 | 108,911 | 6.3 | % | ||||||||
| Biscuits | 25,074 | 24,695 | 1.5 | % | ||||||||
| Handhelds | 16,655 | 5,640 | 195.3 | % | ||||||||
| Coupon redemption | (2,561 | ) | (3,713 | ) | (31.0 | )% | ||||||
| Other | 181 | 485 | (62.7 | )% | ||||||||
| Total Retail Supermarket | $ | 215,428 | $ | 197,943 | 8.8 | % | ||||||
| Retail Supermarket Operating Income | $ | 9,375 | $ | 9,487 | (1.2 | )% |
Sales of products to retail supermarkets increased $17.5 million, or 9%, to $215.4 million in fiscal year 2023. Soft pretzel sales to retail supermarkets were $60.3 million, a decrease of $1.7 million, or 3%, from sales in fiscal 2022. Soft pretzel sales to retail supermarkets were impacted by a softer consumer environment as retailers and grocery chains reported lower traffic in stores and smaller baskets at certain points during fiscal 2023. Sales of frozen novelties increased $6.9 million, or 6%, to $115.8 million in fiscal 2023. Sales of biscuits and dumplings increased 2% to $25.1 million in fiscal 2023. Handheld sales to retail supermarket customers increased 195% to $16.7 million in fiscal 2023, with the increase largely driven by expansion with a major retailer.
Sales of new products in the first twelve months since their introduction in retail supermarkets were approximately $0.6 million in fiscal 2023. Operating income in our Retail Supermarkets segment remained relatively flat in fiscal 2023 as compared with fiscal 2022, with a decrease of $0.1 million, or 1%. The relatively comparative flat operating income was the result of gross margin challenges earlier in fiscal 2023 due to higher promotions and allowances, as well as inflationary pressures on raw material costs, offset by stronger comparative performance in the fiscal third and fourth quarters of 2023, largely driven by improved gross margin and lower distribution expenses.
FROZEN BEVERAGES SEGMENT RESULTS
| Fiscal year ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, | September 24, | |||||||||||
| 2023 | 2022 | |||||||||||
| (53 weeks) | (52 weeks) | % Change | ||||||||||
| (in thousands) | ||||||||||||
| Frozen Beverages | ||||||||||||
| Beverages | $ | 224,655 | $ | 184,063 | 22.1 | % | ||||||
| Repair and maintenance service | 95,941 | 89,840 | 6.8 | % | ||||||||
| Machines revenue | 37,933 | 33,601 | 12.9 | % | ||||||||
| Other | 3,032 | 2,522 | 20.2 | % | ||||||||
| Total Frozen Beverages | $ | 361,561 | $ | 310,026 | 16.6 | % | ||||||
| Frozen Beverages Operating Income | $ | 50,365 | $ | 33,800 | 49.0 | % |
Total frozen beverage segment sales increased $51.5 million or 17% to $361.6 million in fiscal 2023. Beverage sales increased 22%, or $40.6 million, in fiscal 2023. Gallon sales increased 10% from the prior fiscal year. The increase in gallon sales reflects the strong momentum in theaters, along with continued growth in amusement parks, convenience, restaurants, and retail venues. Service revenue increased 7% to $95.9 million in fiscal 2023 and machines revenue, primarily sales of frozen beverage machines, increased from $33.6 million in fiscal 2022 to $37.9 million in fiscal 2023 due to growing installations with new customers.
The estimated number of Company-owned frozen beverage dispensers was 23,000 and 22,000 at September 30, 2023 and September 24, 2022, respectively. Operating income in our Frozen Beverage segment increased 49%, or $16.6 million, in fiscal 2023, with the increase primarily a result of higher beverage sales volume which drove leverage across the business.
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RESULTS OF OPERATIONS:
Fiscal Year 2022 (52 weeks) Compared to Fiscal Year 2021 (52 weeks)
Results of Consolidated Operations
The following discussion provides a review of results for the fiscal year ended September 24, 2022 as compared with the fiscal year ended September 25, 2021.
| Summary of Results | Fiscal year ended | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 24, | September 25, | |||||||||||
| 2022 | 2021 | |||||||||||
| (52 weeks) | (52 weeks) | % Change | ||||||||||
| (in thousands) | ||||||||||||
| Net Sales | $ | 1,380,656 | $ | 1,144,579 | 20.6 | % | ||||||
| Cost of goods sold | 1,011,014 | 845,651 | 19.6 | % | ||||||||
| Gross Profit | 369,642 | 298,928 | 23.7 | % | ||||||||
| Operating expenses | ||||||||||||
| Marketing | 91,636 | 77,922 | 17.6 | % | ||||||||
| Distribution | 159,637 | 108,297 | 47.4 | % | ||||||||
| Administrative | 55,189 | 40,538 | 36.1 | % | ||||||||
| Intangible asset impairment charges | 1,010 | 1,273 | ||||||||||
| Other general expense (income) | 371 | (320 | ) | (215.9 | )% | |||||||
| Total Operating Expenses | 307,843 | 227,710 | 35.2 | % | ||||||||
| Operating Income | 61,799 | 71,218 | (13.2 | )% | ||||||||
| Other income (expense) | ||||||||||||
| Investment income | 980 | 2,815 | (65.2 | )% | ||||||||
| Interest expense | (1,025 | ) | (7 | ) | n.m. | % | ||||||
| Earnings before income taxes | 61,754 | 74,026 | (16.6 | )% | ||||||||
| Income tax expense | 14,519 | 18,419 | (21.2 | )% | ||||||||
| NET EARNINGS | $ | 47,235 | $ | 55,607 | (15.1 | )% |
| Comparisons as a Percentage of Net Sales | Fiscal year ended | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 24, | September 25, | |||||||||||
| 2022 | 2021 | Basis Pt Chg | ||||||||||
| Gross profit | 26.8 | % | 26.1 | % | 70 | |||||||
| Marketing | 6.6 | % | 6.8 | % | (20 | ) | ||||||
| Distribution | 11.6 | % | 9.5 | % | 210 | |||||||
| Administrative | 4.0 | % | 3.5 | % | 50 | |||||||
| Operating income | 4.5 | % | 6.2 | % | (170 | ) | ||||||
| Earnings before income taxes | 4.5 | % | 6.5 | % | (200 | ) | ||||||
| Net earnings | 3.4 | % | 4.9 | % | (150 | ) |
22
NET SALES
Net sales increased $236.1 million, or 21%, to $1,380.7 million in fiscal 2022 from $1,144.6 million in fiscal 2021. The sales growth was largely driven by improved marketing, new customers, additional product placement, as well as a positive pricing environment. Additional benefits were seen from our recent acquisition, and to a lessor extent, from the comparative impact of the COVID-19 pandemic on fiscal 2022 sales compared with fiscal 2021 sales, with most of the latter comparative benefit reflected in our first quarter of fiscal 2022.
GROSS PROFIT
Gross profit as a percentage of sales increased to 26.8% in fiscal 2022 from 26.1% in fiscal 2021. Inflation continued to build over the year which significantly pressured margins. The impact was especially pronounced in key raw material purchases like flour, eggs, dairy, chocolates and meats, as well as packaging and fuel. Pricing actions that were implemented during fiscal 2022 helped to offset some of these significant cost pressures. Comparatively, the increase in gross profit percentage was largely attributable to the benefit of increased sales, as well as favorable product mix.
OPERATING EXPENSES
Total operating expenses increased $80.1 million to $307.8 million in fiscal 2022 and increased as a percentage of sales to 22.3% of sales from 19.9% in fiscal 2021. The increase reflects the significant impact of inflationary pressures across the majority of our cost line items including industry-wide freight and distribution cost increases, wage increases, and overall administrative expense increases.
Operating expenses included intangible asset impairment charges of $1.0 million in fiscal 2022 and $1.3 million in fiscal 2021. Marketing and selling expenses decreased to 6.6% this year from 6.8% of sales in fiscal 2021 driven by effective investment of marketing dollars aligned with sales recovery. Distribution expenses as a percentage of sales increased to 11.6% from 9.5% in fiscal 2021 due to rising freight and fuel costs. Administrative expenses were 4.0% and 3.5% of sales in fiscal 2022 and fiscal 2021, respectively.
OTHER INCOME AND EXPENSE
Our investments generated before tax income of $1.0 million in fiscal 2022, down from $2.8 million in fiscal 2021 due to decreases in the amount of investments.
Interest expense increased by $1.0 million in fiscal 2023 due to the Company’s outstanding borrowings on the Amended Credit Agreement.
INCOME TAX EXPENSE
Our effective tax rate in fiscal 2022 was 23.5%. Our effective tax rate in fiscal 2021 year was 24.9%.
NET EARNINGS
Net earnings decreased $8.4 million, or 15%, in fiscal 2022 to $47.2 million, or $2.46 per diluted share, from $55.6 million or $2.91 per diluted share, in fiscal 2021 as a result of the aforementioned items.
23
Results of Operations - Segments
The following table is a summary of sales and operating income, which is how we measure segment profit.
| Fiscal year ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 24, | September 25, | |||||||||||
| 2022 | 2021 | |||||||||||
| (52 weeks) | (52 weeks) | % Change | ||||||||||
| (in thousands) | ||||||||||||
| Net Sales | ||||||||||||
| Food Service | $ | 872,687 | $ | 724,983 | 20.4 | % | ||||||
| Retail Supermarket | 197,943 | 184,897 | 7.1 | % | ||||||||
| Frozen Beverages | 310,026 | 234,699 | 32.1 | % | ||||||||
| Total Sales | $ | 1,380,656 | $ | 1,144,579 | 20.6 | % |
| Fiscal year ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 24, | September 25, | |||||||||||
| 2022 | 2021 | |||||||||||
| (52 weeks) | (52 weeks) | % Change | ||||||||||
| (in thousands) | ||||||||||||
| Operating Income | ||||||||||||
| Food Service | $ | 18,512 | $ | 39,172 | (52.7 | )% | ||||||
| Retail Supermarket | 9,487 | 25,914 | (63.4 | )% | ||||||||
| Frozen Beverages | 33,800 | 6,132 | 451.2 | % | ||||||||
| Total Operating Income | $ | 61,799 | $ | 71,218 | (13.2 | )% |
FOOD SERVICE SEGMENT RESULTS
| Fiscal year ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 24, | September 25, | |||||||||||
| 2022 | 2021 | |||||||||||
| (52 weeks) | (52 weeks) | % Change | ||||||||||
| (in thousands) | ||||||||||||
| Food Service Sales to External Customers | ||||||||||||
| Soft pretzels | $ | 205,752 | $ | 174,977 | 17.6 | % | ||||||
| Frozen novelties | 78,183 | 44,605 | 75.3 | % | ||||||||
| Churros | 88,242 | 64,916 | 35.9 | % | ||||||||
| Handhelds | 92,130 | 75,627 | 21.8 | % | ||||||||
| Bakery | 381,526 | 342,609 | 11.4 | % | ||||||||
| Other | 26,854 | 22,249 | 20.7 | % | ||||||||
| Total Food Service | $ | 872,687 | $ | 724,983 | 20.4 | % | ||||||
| Food Service Operating Income | $ | 18,512 | $ | 39,172 | (52.7 | )% |
Sales to food service customers increased $147.7 million, or 20%, to $872.7 million in fiscal 2022. Soft pretzel sales to the food service market increased 18% to $205.8 million for the year. Frozen novelties sales increased $33.6 million, or 75%, to $78.2 million for the year, which included the benefit of the Company’s recent acquisition. Churro sales to food service customers were up 36% to $88.2 million for the year. Sales of bakery products increased $38.9 million, or 11%, to $381.5 million for the year. Handheld sales to food service customers were up 22% to $92.1 million in fiscal 2022. Sales of funnel cake increased $4.6 million, or 21%, to $26.9 million.
Sales were up across most product lines as many of the venues and locations where our products are sold that were previously shut down or operating at reduced capacity in fiscal 2021 had mostly or fully re-opened in fiscal 2022. Theaters and outdoor venues, including stadiums and amusement parks, as well as schools, restaurants and strategic accounts continued to experience an increase in visitation that drove strong sales in our core products. Additionally, sales across all of our product lines were favorably impacted by the positive pricing environment, and frozen novelties sales were also favorably impacted by our recent acquisition.
Sales of new products in the first twelve months since their introduction were approximately $4.6 million for the year. Operating income in our Food Service segment decreased from $39.2 million in fiscal 2021 to $18.5 million in fiscal 2022. The decrease in operating income was primarily due to the significant increase in ingredients, production and distribution costs year over year, as well as our ERP implementation which previously impacted our results in the fiscal second quarter of 2022.
24
RETAIL SUPERMARKETS SEGMENT RESULTS
| Fiscal year ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 24, | September 25, | |||||||||||
| 2022 | 2021 | |||||||||||
| (52 weeks) | (52 weeks) | % Change | ||||||||||
| (in thousands) | ||||||||||||
| Retail Supermarket Sales to External Customers | ||||||||||||
| Soft pretzels | $ | 61,925 | $ | 54,990 | 12.6 | % | ||||||
| Frozen novelties | 108,911 | 100,059 | 8.8 | % | ||||||||
| Biscuits | 24,695 | 24,197 | 2.1 | % | ||||||||
| Handhelds | 5,640 | 7,574 | (25.5 | )% | ||||||||
| Coupon redemption | (3,713 | ) | (3,689 | ) | 0.7 | % | ||||||
| Other | 485 | 1,766 | (72.5 | )% | ||||||||
| Total Retail Supermarket | $ | 197,943 | $ | 184,897 | 7.1 | % | ||||||
| Retail Supermarket Operating Income | $ | 9,487 | $ | 25,914 | (63.4 | )% |
Sales of products to retail supermarkets increased $13.0 million, or 7%, to $197.9 million in fiscal year 2022. Soft pretzel sales to retail supermarkets were $61.9 million, an increase of $6.9 million, or 13%, from sales in fiscal 2021. Sales of frozen novelties increased $8.9 million, or 9%, to $108.9 million. Sales of biscuits and dumplings increased 2% to $24.7 million for the year. Handheld sales to retail supermarket customers decreased 26% to $5.6 million for the year.
Sales of new products in the first twelve months since their introduction were approximately $0.9 million in fiscal year 2022. Operating income in our Retail Supermarkets segment decreased from $25.9 million to $9.5 million for the year. The decreases in operating income were primarily attributable to higher cost of goods sold as well as higher shipping and distribution related costs.
FROZEN BEVERAGES SEGMENT RESULTS
| Fiscal year ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 24, | September 25, | |||||||||||
| 2022 | 2021 | |||||||||||
| (52 weeks) | (52 weeks) | % Change | ||||||||||
| (in thousands) | ||||||||||||
| Frozen Beverages | ||||||||||||
| Beverages | $ | 184,063 | $ | 124,498 | 47.8 | % | ||||||
| Repair and maintenance service | 89,840 | 81,305 | 10.5 | % | ||||||||
| Machines revenue | 33,601 | 26,953 | 24.7 | % | ||||||||
| Other | 2,522 | 1,943 | 29.8 | % | ||||||||
| Total Frozen Beverages | $ | 310,026 | $ | 234,699 | 32.1 | % | ||||||
| Frozen Beverages Operating Income | $ | 33,800 | $ | 6,132 | 451.2 | % |
Total frozen beverage segment sales increased 32% to $310.0 million in fiscal 2022 and beverage sales increased 48%, or $59.6 million, for the year. Gallon sales increased 39% from last year. The increase in gallon sales reflects the strong demand across theaters, amusement parks, convenience and restaurants. In the amusement parks channel, we continued to see strong growth as both domestic and international visitation numbers continued to recover, and exceeded, pre-COVID-19 levels. Theater sales continued on an upward trajectory as movie goers indulged in their favorite snacks and view highly anticipated movie releases. Service revenue increased 10% to $89.8 million in fiscal 2022 led by an acceleration in maintenance calls and additional growth in one of our larger customers, earlier in fiscal 2022. Machines revenue, primarily sales of machines, increased from $27.0 million in fiscal 2021 to $33.6 million in fiscal 2022 driven mainly by growth from large quick service restaurant (QSR) and convenience customers.
The estimated number of Company-owned frozen beverage dispensers was 22,000 and 19,000 at September 24, 2022 and September 25, 2021, respectively. Our Frozen Beverage segment had operating income of $33.8 million in fiscal 2022 compared to $6.1 million in fiscal 2021 primarily a result of higher beverage sales volume which drove leverage across the business.
ACQUISITIONS
On June 21, 2022, J & J Snack Foods Corp. and its wholly-owned subsidiary, DD Acquisition Holdings, LLC, completed the acquisition of one hundred percent (100%) of the equity interests of Dippin’ Dots Holding, L.L.C. (“Dippin’ Dots”) which, through its wholly-owned subsidiaries, owns and operates the Dippin’ Dots and Doc Popcorn businesses. The purchase price was approximately $223.6 million, consisting entirely of cash.
Dippin’ Dots is a leading producer of flash-frozen beaded ice cream treats, and the acquisition will leverage synergies in entertainment and amusement locations, theaters, and convenience to continue to expand our business. The acquisition also includes the Doc Popcorn business operated by Dippin’ Dots.
The acquisition was accounted for under the purchase method of accounting, and its operations are included in the accompanying consolidated financial statements from their respective acquisition dates.
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LIQUIDITY AND CAPITAL RESOURCES
Although there are many factors that could impact our operating cash flow, most notably net earnings, we believe that our future operating cash flow, along with our borrowing capacity, our current cash and cash equivalent balances and our investment securities is sufficient to satisfy our cash requirements over the next twelve months and beyond, as well as fund future growth and expansion.
Fiscal 2023 Compared to Fiscal 2022
| September 30, | September 24, | |||||||
|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||||
| (in thousands) | ||||||||
| Cash flows from operating activities | ||||||||
| Net earnings | $ | 78,906 | $ | 47,235 | ||||
| Non-cash items in net income: | ||||||||
| Depreciation of fixed assets | 56,616 | 49,669 | ||||||
| Amortization of intangibles and deferred costs | 6,525 | 3,454 | ||||||
| Intangible asset impairment charges | 1,678 | 1,010 | ||||||
| (Gains) Losses from disposals of property & equipment | (409 | ) | 220 | |||||
| Share-based compensation | 5,318 | 4,269 | ||||||
| Deferred income taxes | 10,935 | 8,829 | ||||||
| (Gain) Loss on marketable securities | (8 | ) | 315 | |||||
| Other | 323 | (95 | ) | |||||
| Changes in assets and liabilities, net of effects from purchase of companies | 12,395 | (88,844 | ) | |||||
| Net cash by operating activities | $ | 172,279 | $ | 26,062 |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | The increase in depreciation of fixed assets was largely due to prior year purchases of property, plant and equipment, as well as depreciation expense related to assets acquired in the fiscal 2022 Dippin’ Dots acquisition. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | The increase in amortization of intangibles and deferred costs was related to intangible assets acquired in the fiscal 2022 Dippin’ Dots acquisition. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | The increase in deferred income taxes was primarily related to increased deferred tax liabilities which arose in connection with overall depreciation related temporary differences in fiscal year 2023. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Cash flows associated with changes in assets and liabilities, net effects from purchase of companies, generated approximately $12.4 million of cash in fiscal 2023 compared with a usage of $88.8 million of cash in fiscal 2022. The generation of cash in fiscal 2023 was largely the result of an improved collections environment, as well as a strategic push to lower our investment in inventory related working capital balances. In fiscal 2022, the usage of cash was primarily due to the increase in accounts receivable, inventory, and prepaid balances. The fiscal 2022 accounts receivable balance increased primarily due to the overall increase in sales in our fourth quarter of fiscal 2022 compared with fiscal 2021. The fiscal 2022 inventory balance increased primarily due to inflationary pressures seen during fiscal 2022, as well as strategic decisions to store more finished goods. The fiscal 2022 prepaid balance increased primarily due to an increase in prepaid income taxes. |
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| September 30, | September 24, | |||||||
|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||||
| (in thousands) | ||||||||
| Cash flows from investing activities | ||||||||
| Payments for purchases of companies, net of cash acquired | - | (221,301 | ) | |||||
| Purchases of property, plant and equipment | (104,737 | ) | (87,291 | ) | ||||
| Proceeds from redemption and sales of marketable securities | 9,716 | 12,026 | ||||||
| Proceeds from disposal of property and equipment | 1,781 | 399 | ||||||
| Net cash (used in) by investing activities | $ | (93,240 | ) | $ | (296,167 | ) |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | In fiscal 2022, the payments for purchases of companies, net of cash acquired, related to the Dippin’ Dots acquisition. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Purchases of property, plant and equipment include spending for production growth, in addition to acquiring new equipment, infrastructure replacements, and upgrades to maintain competitive standing and position us for future opportunities. The increase in fiscal 2023 was primarily due to increased spend for new lines at various plants aimed at increasing capacity. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Proceeds from redemption and sales of marketable securities decreased in fiscal 2023 as in prior years, we strategically chose to no longer re-invest redeemed proceeds into marketable securities given the low interest rate environment. |
| September 30, | September 24, | |||||||
|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | |||||||
| (in thousands) | ||||||||
| Cash flows from financing activities | ||||||||
| Proceeds from issuance of stock | 15,212 | 16,160 | ||||||
| Borrowings under credit facility | 114,000 | 125,000 | ||||||
| Repayment of borrowings under credit facility | (142,000 | ) | (70,000 | ) | ||||
| Payments for debt issuance costs | - | (225 | ) | |||||
| Payments on finance lease obligations | (180 | ) | (279 | ) | ||||
| Payment of cash dividends | (53,877 | ) | (48,437 | ) | ||||
| Net cash (used in) provided by financing activities | $ | (66,845 | ) | $ | 22,219 |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Borrowings under credit facility and repayment of borrowings under credit facility relate to the Company’s cash draws and repayments made to primarily fund working capital needs, as well as the initial draw made in fiscal 2022 to fund the Dippin’ Dots acquisition. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Dividends paid during fiscal 2023 increased as our quarterly dividend was raised during fiscal 2023. |
Liquidity
As of September 30, 2023, we had $49.6 million of cash and cash equivalents.
In December 2021, the Company entered into an amended and restated loan agreement (the “Credit Agreement”) with our existing banks which provided for up to a $50 million revolving credit facility repayable in December 2026.
On June 21, 2022, the Company entered into an amendment to the Credit Agreement, the “Amended Credit Agreement” which provided for an incremental increase of $175 million in available borrowings. The Amended Credit Agreement also includes an option to increase the size of the revolving credit facility by up to an amount not to exceed in the aggregate the greater of $225 million or, $50 million plus the Consolidated EBITDA of the Borrowers, subject to the satisfaction of certain terms and conditions.
Interest accrues, at the Company’s election at (i) the BSBY Rate (as defined in the Credit Agreement), plus an applicable margin, based upon the Consolidated Net Leverage Ratio, as defined in the Credit Agreement, or (ii) the Alternate Base Rate (a rate based on the higher of (a) the prime rate announced from time-to-time by the Administrative Agent, (b) the Federal Reserve System’s federal funds rate, plus 0.50% or (c) the Daily BSBY Rate, plus an applicable margin). The Alternate Base Rate is defined in the Credit Agreement.
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The Credit Agreement requires the Company to comply with various affirmative and negative covenants, including without limitation (i) covenants to maintain a minimum specified interest coverage ratio and maximum specified net leverage ratio, and (ii) subject to certain exceptions, covenants that prevent or restrict the Company’s ability to pay dividends, engage in certain mergers or acquisitions, make certain investments or loans, incur future indebtedness, alter its capital structure or line of business, prepay subordinated indebtedness, engage in certain transactions with affiliates, or amend its organizational documents. As of September 30, 2023, the Company is in compliance with all financial covenants of the Credit Agreement.
As of September 30, 2023, we had $27.0 million of outstanding borrowings drawn on the Amended Credit Agreement. As of September 24, 2022, we had $188.2 million of additional borrowing capacity, after giving effect to the $9.8 million of letters of credit outstanding.
The Company’s material cash requirements include the following contractual and other obligations:
Purchase Commitments
Our most significant raw material requirements include flour, packaging, shortening, corn syrup, sugar, juice, cheese, chocolate, and a variety of nuts. We attempt to minimize the effect of future price fluctuations related to the purchase of raw materials primarily through forward purchasing to cover future manufacturing requirements, generally for periods from 1 to 12 months. As of September 30, 2023, we have approximately $125 million of such commitments. The purchase commitments do not exceed our projected requirements over the related terms and are in the normal course of business.
Leases
We have operating leases with initial noncancelable lease terms in excess of one year covering the rental of various facilities and equipment. Our operating leases include leases for real estate from some of our office, distribution and manufacturing facilities as well as manufacturing and non-manufacturing equipment used in our business. As of September 30, 2023, we have operating lease payment obligations of $94.1 million, with $16.5 million payable within 12 months.
Off –Balance Sheet Arrangements
The Company has off-balance sheet arrangements for purchase commitments as of September 30, 2023.
Critical Accounting Policies, Judgments and Estimates
We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of those financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The Company discloses its significant accounting policies in the accompanying notes to its audited consolidated financial statements.
Judgments and estimates of uncertainties are required in applying the Company’s accounting policies in certain areas. Following are some of the areas requiring significant judgments and estimates: revenue recognition, allowance for estimated credit losses, valuation of goodwill and long-lived and intangible assets, insurance reserves, and income taxes and business combinations.
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Revenue Recognition
The singular performance obligation of our customer contracts for product and machine sales is determined by each individual purchase order and the respective products ordered, with revenue being recognized at a point-in-time when the obligation under the terms of the agreement is satisfied and product control is transferred to our customer. Specifically, control transfers to our customers when the product is delivered to, installed, or picked up by our customers based upon applicable shipping terms, as our customers can direct the use and obtain substantially all of the remaining benefits from the product at this point in time. The performance obligations in our customer contracts for product are generally satisfied within 30 days.
The singular performance obligation of our customer contracts for time and material repair and maintenance equipment service is the performance of the repair and maintenance with revenue being recognized at a point-in-time when the repair and maintenance is completed.
The singular performance obligation of our customer repair and maintenance equipment service contracts is the performance of the repair and maintenance with revenue being recognized over the time the service is expected to be performed. Our customers are billed for service contracts in advance of performance and therefore we have contract liability on our balance sheet.
Revenue is measured by the transaction price, which is defined as the amount of consideration we expect to receive in exchange for satisfying the performance obligations noted above. The transaction price is adjusted for estimates of known or expected variable consideration which includes sales discounts, trade promotions and certain other sales and customer incentives, including rebates and coupon redemptions. Variable consideration related to these programs is recorded as a reduction to revenue when the related revenue is recognized, and is recorded using the most likely amount method, with updates to estimates and related accruals of variable consideration occurring each period based on historical experience, changes in circumstances and other factors, including review of contractual pricing and rebate arrangements with customers.
We do not believe that there is a reasonable likelihood that there will be material change in the estimates or assumptions used to recognize revenue. As noted above, estimates are made based on historical experience and other factors. However, if the level of redemption rates or performance was to vary significantly from estimates, we may be exposed to gains or losses that could be material. We have not made any material changes in the accounting methodology used to recognize revenue during the past three fiscal years.
Allowance for Estimated Credit Losses
We provide an allowance for estimated credit losses after taking into consideration historical experience and other factors. On September 27, 2020, the Company adopted guidance issued by the FASB in ASU 2016-13 Measurement of Credit Losses on Financial Instruments, which requires companies to recognize an allowance that reflects a current estimate of credit losses expected to be incurred over the life of the asset. The Company continuously monitors collections and payments from its customers and maintains a provision for estimated credit losses. The allowance for estimated credit losses considers a number of factors including the age of receivable balances, the history of losses, expectations of future credit losses and the customers’ ability to pay off obligations.
We do not believe that there is a reasonable likelihood that there will be a material change in the estimates or assumptions used to value our accounts receivable. Since adoption of the new guidance on September 27, 2020, we have not made any material changes in the accounting methodology used to value accounts receivable.
Valuation of Goodwill
We have three reporting units with goodwill. Goodwill is evaluated annually by the Company for impairment. We perform impairment tests at year end for our reporting units, which are also the operating segment levels with recorded goodwill utilizing primarily the discounted cash flow method. This methodology used to estimate the fair value of the total Company and its reporting units requires inputs and assumptions (i.e. revenue growth, operating profit margins, capital spending requirements and discount rates) that reflect current market conditions. The estimated fair value of each reporting unit is compared to the carrying value of the reporting unit. If the carrying value of the reporting unit exceeds its fair value, the goodwill of the reporting unit is potentially impaired, and the Company then determines the implied fair value of goodwill, which is compared to the carrying value of goodwill to determine if impairment exists. Our tests at September 30, 2023 show that the fair value of each of our reporting units with goodwill exceeded its carrying value by at least 50%. Therefore, no further analysis was required.
The inputs and assumptions used involve considerable management judgment and are based upon assumptions about expected future operating performance. Assumptions used in these forecasts are consistent with internal planning. The actual performance of the reporting units could differ from management’s estimates due to changes in business conditions, operating performance, economic conditions, competition, and consumer preferences. We have not made any material changes in the accounting methodology used to value goodwill during the past three fiscal years.
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Valuation of Long-Lived Assets and Other Intangible Assets
We record an impairment charge to property, plant and equipment and amortizing intangible assets in accordance with the applicable accounting standards, when, based on certain indicators of impairment, we believe such assets have experienced a decline in value that is other than temporary. Future adverse changes in market conditions or poor operating results of these underlying assets could result in losses or an inability to recover the carrying value of the asset that may not be reflected in the asset’s current carrying value, thereby possibly requiring impairment charges in the future.
Indefinite lived intangibles are reviewed annually for impairment. The fair value of our indefinite lived intangible assets is calculated using either a relief from royalty valuation approach, or the excess earnings method. We are required to make estimates and assumptions about sales growth, royalty rates, and discount rates based on budgets, business plans, economic projections, and marketplace data. Our impairment analysis contains uncertainties due to uncontrollable events that could positively or negatively impact the future economic and operating conditions.
We have not made any material changes in the accounting methodology used to evaluate impairment of long-lived assets and other intangibles during the last three fiscal years. While we believe we have made reasonable estimates and assumptions to calculate fair value of these assets, it is possible a material change could occur. If our actual results are not consistent with our estimates and assumptions used to calculate fair value, it could result in a material impairment of our long-lived assets and other intangibles.
Insurance Reserves
We have a self-insured medical plan which covers approximately 1,800 of our employees. We record a liability for incurred but not yet reported or paid claims based on our historical experience of claims payments and a calculated lag time period. Considering that we have stop loss coverage of $225,000 for each individual plan subscriber, the general consistency of claims payments and the short time lag, we believe that there is not a material exposure for this liability.
We self-insure, up to loss limits, workers’ compensation, automobile and general liability claims. Insurance reserves are calculated on a combination of an undiscounted basis based on actual claims data and estimates of incurred but not reported claims developed utilizing historical claims trends. Projected settlements of incurred but not reported claims are estimated based on pending claims, historical trends, industry trends related to expected losses and actual reported losses, and key assumptions, including loss development factors and expected loss rates.
We have not made any material changes in the accounting methodology used to establish our self-insurance liability during the past three fiscal years. We do not believe that there is a reasonable likelihood that there will be a material change in the estimate or assumptions used to calculate our self-insurance liability. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to gains or losses that could be material.
Income Taxes
The annual tax rate is based on our income and statutory tax rates. Changes in statutory rates and tax laws in jurisdictions in which we operate may have a material effect on our annual tax rate. The effect of these changes, if any, would be recognized as a discrete item upon enactment.
Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenues and expenses. Deferred tax assets and liabilities are measured based on the enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid.
We have not made any material changes in the accounting methodology used to account for income taxes during the past three fiscal years. Changes in tax laws and rates could affect recorded deferred tax assets and liabilities in the future. Other than those potential impacts, we do not believe there is a reasonable likelihood that there will be a material change in tax related balances.
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Business Combinations
We use assumptions and estimates in determining the fair value of assets acquired and liabilities assumed in a business combination. We use various models to value assets acquired and liabilities assumed, such as the net realizable value method to value inventory, and the cost method and market approach to value property, plant and equipment. The determination of the fair value of intangible assets, which can represent a significant portion of the purchase price of our acquisitions, requires the use of significant judgement with regard to the fair value, and whether such intangibles are amortizable or non-amortizable and, if the former, the period and method by which the intangible will be amortized. We estimate the fair value of acquisition-related intangibles either through the relief of royalty method or multi-period excess earnings method, or based on projections of cash flows that will arise from identifiable intangible assets of acquired businesses, which includes estimate of customer attrition. The projected cash flows are discounted to determine the present value of the assets at the date of acquisition. For significant acquisitions, we may use independent third-party valuation specialists to assist us in determining the fair value of assets acquired and liabilities assumed.
We have not made any material changes in the accounting methodology used to account for business combinations during the past three fiscal years. We do not believe that there is a reasonable likelihood that there will be a material change in the estimate or assumptions used to determine the fair value of assets acquired or liabilities assumed in a business combination. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to impairment charges that could be material.
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