Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain commodity and interest rate risks as part of our ongoing business operations. We may use derivative financial instruments, where appropriate, to manage some of these risks related to interest rates. We do not use derivatives for trading purposes.
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Commodity Risk
We purchase certain raw materials that are subject to price volatility caused by weather, market conditions, growing and harvesting conditions, governmental actions and other factors beyond our control. Our most significant raw material requirements include potatoes, oil, flour, wheat, corn, cheese, spices, and seasonings. We also purchase packaging materials that are subject to price volatility. In the normal course of business, in order to mitigate the risks of volatility in commodity markets to which we are exposed, we enter into forward purchase agreements with certain suppliers based on market prices, forward price projections and expected usage levels. Amounts committed under these forward purchase agreements are discussed in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations under the section “Derivative Financial Instruments” of this Annual Report on Form 10-K. A 1% increase in the price of the commodities used within our products and packaging would result in a reduction of our gross profit of approximately $5.0 million.
Interest Rate Risk
Our variable-rate debt obligations incur interest at floating rates based on changes in the SOFR rate. To manage exposure to changing interest rates, we selectively enter into interest rate swap agreements to maintain a desired proportion of fixed to variable-rate debt. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations under the section “Derivative Financial Instruments” for further information related to our interest rate swap agreements. These interest rate swap agreements fixed a portion of the interest rate at a predictable level. Interest expense would have been $1.7 million higher without these swaps during the fiscal year ended January 1, 2023. Including the effect of the interest rate swap agreements, the weighted average interest rate was 5.5% and 3.5%, respectively, as of January 1, 2023 and January 2, 2022. A 1% increase in the SOFR rate would have resulted in an additional $2.8 million of interest expense during the fiscal year 2022 based on the unhedged portion of debt.
Credit Risk
We are exposed to credit risks related to our accounts and notes receivable. We perform ongoing credit evaluations of our customers to minimize the potential exposure. We experienced no material credit losses during the fiscal years of 2022 or 2021. During the fiscal year ended January 1, 2023 and the fiscal year ended January 2, 2022, net bad deb t expense w as $0.9 million and $0.4 million, respectively. Our reserve for potential future bad debt was $1.8 million as of January 1, 2023 and $1.4 million as of January 2, 2022.