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
information related to the discussion and analysis of our financial condition
and results of operations for the fiscal year ended
to the fiscal year ended
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 believe we are the largest manufacturer of soft
pretzels in
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 economy that impact 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.
Inflation
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.
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RESULTS OF OPERATIONS:
Fiscal Year 2022 (52 weeks) Compared to Fiscal Year 2021 (52 weeks)
Results of Consolidated Operations
Net sales increased
from
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 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.
Total operating expenses increased
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
in fiscal 2022 and
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 percent 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.
Operating income decreased
2022 as a result of the aforementioned items.
Our investments generated before tax income of
from
Our effective tax rate in fiscal 2022 was 23.5%. Our effective tax rate in
fiscal 2021 year was 24.9%.
Net earnings decreased
fiscal 2021 as a result of the aforementioned items.
There are many factors which can impact our net earnings from year to year and
in the long run, 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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FOOD SERVICE
Sales to food service customers increased
million
18% to
million
the Company’s recent acquisition. Churro sales to food service customers were up
36% to
million
customers were up 22% to
increased
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 have mostly 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
segment decreased from
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.
RETAIL SUPERMARKETS
Sales of products to retail supermarkets increased
million
Sales of frozen novelties increased
of biscuits and dumplings increased 2% to
sales to retail supermarket customers decreased 26% to
year.
Sales of new products in the first twelve months since their introduction were
approximately
Supermarkets segment decreased from
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
Total frozen beverage segment sales increased 32% to
2022 and beverage sales increased 48% or
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 continue to see strong growth as both domestic
and international visitation numbers continue to recover, and exceed,
pre-COVID-19 levels. Theater sales continue on their upward trajectory as movie
goers indulge in their favorite snacks and view highly anticipated movie
releases. Service revenue increased 10% to
acceleration in maintenance calls and additional growth in one of our larger
customers, earlier in the fiscal year. Machines revenue, primarily sales of
machines, increased from
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
Beverage segment had operating income of
to
volume which drove leverage across the business.
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RESULTS OF OPERATIONS:
Fiscal Year 2021 (52 weeks) Compared to Fiscal Year 2020 (52 weeks)
Net sales increased
from
operations continued to open, sales for the year improved from a year ago.
Approximately 2/3 of the Company’s sales are to venues and locations that
previously shut down or sharply curtailed their foodservice operations as a
result of COVID-19.
FOOD SERVICE
Sales to food service customers increased
million
16% to
million
customers were up 38% to
increased
to food service customers were up 110% to
cake increased
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 2020 have
partially or fully re-opened in 2021.
Sales of new products in the first twelve months since their introduction were
approximately
segment increased from
increase in operating income was primarily due to the increase in sales which
improved margin efficiencies and expense leverage.
RETAIL SUPERMARKETS
Sales of products to retail supermarkets increased
million
frozen novelties increased
biscuits and dumplings decreased 15% to
sales to retail supermarket customers decreased 38% to
year.
Sales of new products in the first twelve months since their introduction were
approximately
Supermarkets segment increased from
primarily due to higher volume.
FROZEN BEVERAGES
Total frozen beverage segment sales increased 4% to
2021 and beverage sales increased 16% or
sales increased 16% from last year. Service revenue decreased 3% to
million
2020
million
customer. Overall, sales in the frozen beverage segment grew as key amusement,
convenience, restaurants, and retail venues returned to pre-COVID capacity in
the second half of the year, which offset a slower recovery in the theater
channel.
The estimated number of Company-owned frozen beverage dispensers was 19,000 and
27,000 at
Beverage segment had operating income of
operating loss of
sales volume due to COVID-19 recovery during 2021.
CONSOLIDATED
Other than as commented upon above by segment, there are no material specific
reasons for the reported sales increases or decreases. Sales levels can be
impacted by the appeal of our products to our customers and consumers and their
changing tastes, competitive and pricing pressures, sales execution, marketing
programs, seasonal weather, customer stability and general economic conditions.
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Gross profit as a percentage of sales increased to 26.1% in 2021 from 23.3% in
2020. The increase is largely attributable to the benefit of increased sales,
favorable product mix and corresponding margin efficiencies.
Total operating expenses increased
but as a percentage of sales decreased to 19.9% of sales from 21.6% in 2020.
Operating expenses this year included
impairment charges and operating expenses in 2020 included
shutdown impairment costs for the shutdown of one of our manufacturing plants.
Marketing and selling expenses decreased to 6.8% this year from 8.3% of sales in
2020 driven by effective investment of marketing dollars aligned with sales
recovery. Distribution expenses as a percent of sales increased to 9.5% from
9.1% in 2020 due to rising freight and fuel costs. Administrative expenses were
3.5% and 3.6% of sales in 2021 and 2020, respectively.
Operating income increased
2021 as a result of the aforementioned items.
Our investments generated before tax income of
interest rates.
Our effective tax rate in our fiscal 2021 year was 24.9%. Net earnings for the
2020 year benefited from a reduction in income tax expense related to state
deferred taxes of approximately
effective tax rate in our fiscal 2020 year was 25.0%.
Net earnings increased
or
fiscal 2020 as a result of the aforementioned items.
There are many factors which can impact our net earnings from year to year and
in the long run, 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.
ACQUISITIONS
On
business in
Distributors
2021
On
Alabama
million
BAMA ICEE were
2020
On
Acquisition Holdings, LLC
(100%) of the equity interests of
which, through its wholly-owned subsidiaries, owns and operates the Dippin’ Dots
and Doc Popcorn businesses. The purchase price was approximately
consisting entirely of cash, and may be modified for certain customary
post-closing purchase price adjustments.
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.
These acquisitions were accounted for under the purchase method of accounting,
and their 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 2022 Compared to Fiscal 2021
September 24, September 25,
2022 2021
(in thousands)
Cash flows from operating activities
Net earnings $ 47,235 $ 55,607
Non-cash items in net income:
Depreciation of fixed assets 49,669 46,781
Amortization of intangibles and deferred costs 3,454 2,610
Intangible asset impairment charges 1,010 1,273
Losses (Gains) from disposals of property & equipment 220 (231 )
Share-based compensation 4,269 4,199
Deferred income taxes 8,829 (2,896 )
Loss (Gain) on marketable securities 315 (1,026 )
Other (95 ) 77
Changes in assets and liabilities, net of effects from
purchase of companies
(88,844 ) (4,895 ) Net cash provided by operating activities$ 26,062 $ 101,499 - 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 2022. - Cash flows associated with changes in assets and liabilities, net effects from purchase of companies decreased in fiscal year 2022 largely due to the increase in accounts receivable, inventory, and prepaid balances. The accounts receivable balance increased primarily due to the overall increase in sales in our fourth quarter of fiscal 2022 compared with fiscal 2021. The inventory balance increased primarily due to inflationary pressures seen during fiscal 2022, as well as strategic decisions to store more finished goods. The prepaid balance increased primarily due to an increase in prepaid income taxes. 20
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September 24, September 25,
2022 2021
(in thousands)
Cash flows from investing activities
Payments for purchases of companies, net of cash acquired (221,301 ) -
Purchases of property, plant and equipment (87,291 ) (53,578 )
Proceeds from redemption and sales of marketable securities 12,026 60,891
Proceeds from disposal of property and equipment 399 2,435
Other - 191
Net cash (used in) provided by investing activities $ (296,167 ) $ 9,939
- Payments for purchases of companies, net of cash acquired, in fiscal 2022
related to the Dippin' Dots acquisition.
- 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 2022 was primarily due to increased
spend for new lines at various plants aimed at increasing capacity.
- Proceeds from redemption and sales of marketable securities decreased in
fiscal 2022 as in prior years, we strategically chose to no longer re-invest
redeemed proceeds into marketable securities given the low interest rate
environment.
September 24, September 25,
2022 2021
(in thousands)
Cash flows from financing activities
Proceeds from issuance of stock 16,160 20,256
Borrowings under credit facility 125,000 -
Repayment of borrowings under credit facility (70,000 ) -
Payments for debt issuance costs (225 ) -
Payments on finance lease obligations (279 ) (144 )
Payment of cash dividends (48,437 ) (44,785 )
Net cash provided by (used in) financing activities
- Borrowings under credit facility in fiscal 2022 related to funding used to
supplement available cash balances for the Dippin' Dots acquisition.
- Repayment of borrowings under credit facility in fiscal 2022 related to the
cash paydown of borrowings, primarily resulting from the generation of
operating cash subsequent to the acquisition.
- Dividends paid during fiscal 2022 increased as our quarterly dividend was
raised during fiscal 2022.
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Liquidity
As of
In
agreement (the “Credit Agreement”) with our existing banks which provided for up
to a
On
the “Amended Credit Agreement” which provided for an incremental increase of
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
million
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 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.
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
with all financial covenants of the Credit Agreement.
As of
on the Amended Credit Agreement. As of
of additional borrowing capacity, after giving effect to the
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
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 and manufacturing
facilities as well as manufacturing and non-manufacturing equipment used in our
business. As of
of
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Off -Balance Sheet Arrangements
The Company has off-balance sheet arrangements for purchase commitments as of
Critical Accounting Policies, Judgments and Estimates
We prepare our financial statements in conformity with accounting principles
generally accepted in
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 doubtful
receivables, valuation of goodwill and long-lived and intangible assets,
insurance reserves, and income taxes and business combinations.
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.
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Allowance for Doubtful Receivables
We provide an allowance for doubtful receivables after taking into consideration
historical experience and other factors. On
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 doubtful accounts 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
not made any material changes in the accounting methodology used to value
accounts receivable.
Valuation ofGoodwill
We have three reporting units with goodwill.
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
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.
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 principally using
a relief from royalty valuation approach. 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.
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Insurance Reserves
We have a self-insured medical plan which covers approximately 1,700 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. We maintain a spreadsheet that includes claims payments made
each month according to the date the claim was incurred. This enables us to have
an historical record of claims incurred but not yet paid at any point in the
past. We then compare our accrued liability to the more recent claims incurred
but not yet paid amounts and adjust our recorded liability up or down
accordingly. Considering that we have stop loss coverage of
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. Accruals for claims under our self-insurance program are
recorded on a claims-incurred basis. We estimate the liability based on total
incurred claims and paid claims adjusting for loss development factors which
account for the development of open claims over time. We estimate the amounts we
expect to pay for some insurance years by multiplying incurred losses by a loss
development factor which is based on insurance industry averages and the age of
the incurred claims; our estimated liability is then the difference between the
amounts we expect to pay and the amounts we have already paid for those years.
Loss development factors that we use range from 1.0 to 2.0. However, for some
years, the estimated liability is the difference between the amounts we have
already paid for that year and the maximum we could pay under the program in
effect for that particular year because the calculated amount we expect to pay
is higher than the maximum. For other years, where there are few claims open,
the estimated liability we record is the amount the insurance company has
reserved for those claims. We evaluate our estimated liability on a continuing
basis and adjust it accordingly. Due to the multi-year length of these insurance
programs, there is exposure to claims coming in lower or higher than
anticipated; however, due to constant monitoring and stop loss coverage of
of the foregoing, we do not engage a third-party actuary to assist in this
analysis.
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.
25
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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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