Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations, which we refer to as “MD&A,” should be read in conjunction with our condensed consolidated financial statements and related notes included in "Financial Information" of this Quarterly Report on Form 10-Q (this "Form 10-Q") and in “Financial Statements and Supplementary Data” of the Company's Annual Report on Form 10-K for the fiscal year ended May 30, 2021 (the “Form 10-K”), which we filed with the U.S. Securities and Exchange Commission (“SEC”) on July 27, 2021.
Forward-Looking Statements
This report, including the MD&A, contains forward-looking statements within the meaning of the federal securities laws. Words such as “will,” “continue,” “may,” “expect,” “anticipate,” “believe,” “estimate,” “grow,” “take,” “mitigate,” “support,” “remain,” “increase,” “manage,” “improve,” “create,” “outlook,” and variations of such words and similar expressions are intended to identify forward-looking statements. Examples of forward-looking statements include, but are not limited to, statements regarding our plans, execution, capital investments, operational costs, pricing actions, cash flows, liquidity, dividends, share repurchases, enterprise resource planning (“ERP”) system implementation and business outlook and prospects, as well as supply chain constraints, inflation, and the impact of the COVID-19 pandemic on our industry and the global economy. These forward-looking statements are based on management’s current expectations and are subject to uncertainties and changes in circumstances. Readers of this report should understand that these statements are not guarantees of performance or results. Many factors could affect our actual financial results and cause them to vary materially from the expectations contained in the forward-looking statements, including those set forth in this report. These risks and uncertainties include, among other things: the availability and prices of raw materials; labor shortages and other operational challenges; disruptions in the global economy caused by Russia’s invasion of Ukraine and the possible related heightening of our other known risks; impacts on our business due to health pandemics or other contagious outbreaks, such as the COVID-19 pandemic, including impacts on demand for our products, increased costs, disruption of supply, other constraints in the availability of key commodities and other necessary services or restrictions imposed by public health authorities or governments; levels of pension, labor and people-related expenses; our ability to successfully execute our long-term value creation strategies; our ability to execute on large capital projects, including construction of new production lines or facilities; the competitive environment and related conditions in the markets in which we and our joint ventures operate; political and economic conditions of the countries in which we and our joint ventures conduct business and other factors related to our international operations; disruption of our access to export mechanisms; risks associated with possible acquisitions, including our ability to complete acquisitions or integrate acquired businesses; our debt levels; changes in our relationships with our growers or significant customers; the success of our joint ventures; actions of governments and regulatory factors affecting our businesses or joint ventures; the ultimate outcome of litigation or any product recalls; our ability to pay regular quarterly cash dividends and the amounts and timing of any future dividends; and other risks described in our reports filed from time to time with the SEC, including in “Part II – Other Information – Item 1A. Risk Factors” in this report. We caution readers not to place undue reliance on any forward-looking statements included in this report, which speak only as of the date of this report. We undertake no responsibility for updating these statements, except as required by law.
Overview
Lamb Weston Holdings, Inc. (“we,” “us,” “our,” “the Company,” or “Lamb Weston”), along with our joint ventures, is a leading global producer, distributor, and marketer of value-added frozen potato products. We, along with our joint ventures, are the number one supplier of value-added frozen potato products in North America and a leading supplier of value-added frozen potato products internationally, with a strong and growing presence in high-growth emerging markets. We, along with our joint ventures, offer a broad product portfolio to a diverse channel and customer base in over 100 countries. French fries represent the majority of our value-added frozen potato product portfolio.
This MD&A is provided as a supplement to the consolidated financial statements and related condensed notes included elsewhere herein to help provide an understanding of our financial condition, changes in financial condition and results of our operations. Our MD&A is based on financial data derived from the financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and certain other financial data (including
19
Table of Contents
product contribution margin, on a consolidated basis, Adjusted EBITDA and Adjusted EBITDA including unconsolidated joint ventures) that is prepared using non-GAAP financial measures. Refer to “Non-GAAP Financial Measures” below for the definitions of product contribution margin, Adjusted EBITDA, and Adjusted EBITDA including unconsolidated joint ventures, and a reconciliation of these non-GAAP financial measures to gross profit, net income or diluted earnings per share, as applicable.
Executive Summary
We continued to make financial and operating progress in our fiscal third quarter of 2022 as we navigated through a volatile macro environment. We generated solid net sales growth through strong execution of pricing actions to manage significant input cost and manufacturing and supply chain cost inflation. These pricing actions, along with our efforts to control costs, drove earnings growth both sequentially and versus the prior year quarter, despite the COVID-19 Omicron variant affecting demand across our restaurant and foodservice channels, and disrupting production and distribution operations. Specifically, compared with the prior year quarter and during the quarter:
● Net sales increased 7% to $955.0 million
● Income from operations increased 33% to $133.8 million
● Net income increased 61% to $106.6 million
● Diluted earnings per share increased 62% to $0.73
● Adjusted EBITDA including unconsolidated joint ventures increased 31% to $219.6 million
● We returned $84.3 million of cash to stockholders, including $34.3 million in dividends and $50.0 million of share repurchases
Net sales growth in the third quarter of fiscal 2022, compared with the prior year quarter, was driven by higher price/mix, partially offset by lower sales volumes. The increase in price/mix reflected the benefit of product pricing actions across each of our business segments to offset cost inflation, as well as higher prices charged for product delivery. The decline in sales volume reflected lower export volumes, which are included in our Global segment, and was a result of limited shipping container availability along the U.S. West Coast and disruptions to ocean freight networks across the Pacific Ocean. The sales volume decline also reflected lower shipments of private label and branded products in our Retail segment, largely due to our inability to fully serve customer demand due to widespread industry supply chain constraints, including labor and commodities shortages, that resulted in lower production run-rates and throughput in our factories. The decline was partially offset by higher sales volumes to restaurant and foodservice channels in North America as demand continued to rebound to pre-pandemic levels. The increase in sales volumes was most pronounced in our Foodservice segment, which has a higher proportion of its sales to on-premise dining establishments, including independent restaurants and non-commercial operations, such as lodging and hospitality, healthcare, schools and universities, sports and entertainment, and workplace environments. Sales volumes to our large chain quick service restaurant (“QSR”) and casual dining restaurant customers in the U.S., which are included in our Global segment, also increased.
Sales volumes in Europe, which is served by our Lamb-Weston/Meijer joint venture, increased as restaurant traffic continued to improve, although earnings were negatively affected by inflation, production, and transportation challenges.
Income from operations increased largely due to favorable price/mix, which more than offset the higher manufacturing and distribution costs on a per pound basis and the impact of lower sales volumes. The increase in costs per pound primarily reflected double-digit cost inflation from key inputs and transportation. In addition, the increase in costs per pound reflected higher costs and inefficiencies related to labor shortages across our manufacturing network, as well as lower raw potato utilization rates due to the poor crop in the Pacific Northwest that was harvested in fall 2021. The increase in income from operations was also due to lower selling, general and administrative (“SG&A”) expenses that were largely driven by lower consulting expenses, employee-related costs, and advertising and promotion (“A&P”) expenses.
20
Table of Contents
Outlook
We expect our net sales in fiscal 2022 to increase versus the prior year driven by a combination of higher price/mix and higher sales volumes. We expect price/mix to increase largely due to pricing actions that we began to implement earlier in fiscal 2022 in an effort to mitigate manufacturing and distribution cost inflation. For the year, we expect sales volumes to grow as global demand for frozen potato products continues to rise. During the first three quarters of fiscal 2022, aggregate demand in the U.S. continued to rebound to pre-pandemic levels, although growth in our shipments was tempered by our inability to fully serve customer demand due to widespread industry supply chain constraints that resulted in lower production run-rates and throughput in our factories. The rate of recovery in demand in our key international markets remained mixed, while the recovery in our international shipments was also tempered by limited shipping container availability and disruptions to ocean freight networks. We expect overall frozen potato demand in the U.S. and in our key international markets will continue to be solid through the remainder of this fiscal year, although our sales volumes may be tempered by further disruptions in our production and logistics networks, the effect of the COVID-19 variants on restaurant traffic and consumer demand, and inflationary pressures on consumers.
We expect our earnings in fiscal 2022 to be pressured as compared to pre-pandemic levels largely as a result of input cost inflation, including higher raw potato costs, and industrywide supply chain challenges. We anticipate that the rate of inflation for many of our manufacturing, commodity, and transportation costs, including, but not limited to edible oils, grains and starches used for product coatings, energy, labor, rail, trucking, ocean freight, and packaging, will remain higher than we experienced in fiscal 2021. We also expect our potato costs on a per pound basis will rise through the remainder of fiscal 2022 due to the impact of the extreme summer heat that negatively affected the yield and quality of potato crops in the Pacific Northwest. We anticipate the ongoing effects of the pandemic, disruptions to the broader global supply chain and disruptions in the global economy caused by Russia’s invasion of Ukraine, will continue to pressure our operations, including the shortage of manufacturing labor and commodities, through the remainder of fiscal 2022, which is expected to lead to volatile operating conditions and incremental manufacturing and distribution costs. Our experienced team is continuing to take specific actions to mitigate these challenges, most notably executing pricing actions intended to offset commodity inflation, restructuring freight policies, modifying production and crewing schedules, adopting new policies and practices to attract and retain manufacturing employees, and optimizing our product portfolio.
In addition, we expect overall SG&A in fiscal 2022 will be higher than the prior year largely due to increased investments to improve our information technology infrastructure over the long term. This includes resuming our efforts in the second half of fiscal 2022 to design the next phase of a new ERP system.
In March 2022, as a result of Russia’s invasion of Ukraine, Lamb-Weston/Meijer’s joint venture paused construction of its previously announced capacity expansion and began winding down production of Lamb Weston branded products. In addition, Lamb-Weston/Meijer ceased shipping products into Russia. While the joint venture continues to produce and sell food for domestic consumption, the current sanctions imposed by governments in the United States, United Kingdom, and European Union against Russia, as well as additional steps taken by the joint venture’s customers, suppliers, or other stakeholders, may disrupt the plant’s ability to operate in the future. Through the first three quarters of fiscal 2022, approximately 2% of our net income was attributable to business conducted through Lamb-Weston/Meijer’s joint venture, and the portion of our Lamb-Weston/Meijer interest related to its operations in Russia was approximately $55 million as of February 27, 2022.
We remain focused on our strategic objectives, and believe that our investments in productivity, technology, and capacity to support customer growth will create value for our stakeholders over the long term.
21
Table of Contents
Results of Operations
We have four reportable segments: Global, Foodservice, Retail, and Other. We report net sales and product contribution margin by segment and on a consolidated basis. Product contribution margin, when presented on a consolidated basis, is a non-GAAP financial measure. Net sales and product contribution margin are the primary measures reported to our chief operating decision maker for purposes of allocating resources to our segments and assessing their performance. Product contribution margin represents net sales less cost of sales and A&P expenses. Product contribution margin includes A&P expenses because those expenses are directly associated with the performance of the Company’s segments. For additional information on our reportable segments and product contribution margin, see “Non-GAAP Financial Measures” below and Note 13, Segments, of the Condensed Notes to Consolidated Financial Statements in “Part I, Item 1. Financial Statements” of this report.
Thirteen Weeks Ended February 27, 2022 compared to Thirteen Weeks Ended February 28, 2021
Net Sales, Gross Profit, and Product Contribution Margin
Thirteen Weeks Ended
February 27,
February 28,
%
(in millions)
2022
2021
Inc/(Dec)
Segment net sales
Global
$
487.9
$
478.5
2%
Foodservice
294.5
219.5
34%
Retail
143.6
162.5
(12%)
Other
29.0
35.3
(18%)
$
955.0
$
895.8
7%
Segment product contribution margin
Global
$
73.0
$
79.3
(8%)
Foodservice
106.7
70.2
52%
Retail
31.6
33.1
(5%)
Other
6.2
8.7
(29%)
217.5
191.3
14%
Add: Advertising and promotion expenses
3.5
5.4
(35%)
Gross profit
$
221.0
$
196.7
12%
Net Sales
Compared to the prior year quarter, Lamb Weston’s net sales for the third quarter of fiscal 2022 increased $59.2 million, or 7%, to $955.0 million. Price/mix increased 12%, primarily reflecting the benefit of pricing actions across each of our business segments to offset input, manufacturing and transportation cost inflation. Volume declined 5%, reflecting lower export volume and lower shipments to retail channels. We increased shipments to restaurant and foodservice channels in North America, although growth was tempered by softer restaurant traffic as a result of the effects of the Omicron variant and our inability to fully serve customer demand due to widespread industry supply chain constraints that resulted in lower production run-rates and throughput in our factories.
Global segment net sales increased $9.4 million, or 2%, to $487.9 million. Price/mix increased 8% while volume decreased 6%. The benefit of domestic and international product and freight pricing actions to offset inflation, as well as favorable mix, drove the increase in price/mix. Lower export shipments due to limited shipping container availability and disruptions to ocean freight networks drove the decline in sales volumes. Sales volumes to North American large QSR and casual dining restaurant chain customers increased, although growth was tempered by softer consumer traffic as a result of the effects of the Omicron variant.
Foodservice segment net sales increased $75.0 million, or 34%, to $294.5 million. Price/mix increased 22% and volume increased 12%. The benefits of product and freight pricing actions taken earlier in the year to offset inflation, as
22
Table of Contents
well as favorable mix, drove the increase in price/mix. The ongoing recovery in demand at full-service restaurants and in non-commercial channels (such as lodging and hospitality, healthcare, schools and universities, sports and entertainment, and workplace environments) drove the increase in sales volumes. While shipments to restaurants have essentially returned to pre-pandemic levels, demand in non-commercial channels remain below pre-pandemic levels. The segment’s overall volume growth was tempered by softer restaurant and non-commercial traffic as a result of the effects of the Omicron variant, as well as our inability to fully serve customer demand due to widespread industry supply chain constraints that resulted in lower production run-rates and throughput in our factories.
Retail segment net sales declined $18.9 million, or 12%, to $143.6 million. Volume declined 24% while price/mix increased 12%. Lower shipments of private label products, resulting from incremental losses of certain low-margin business, as well as lower shipments of branded products drove the sales volume decline. The decline in branded product shipments reflected our inability to fully serve customer demand due to widespread industry supply chain constraints that resulted in lower production run-rates and throughput in our factories. Product and freight pricing actions across our branded and private label portfolios to offset inflation, as well as improved mix, drove the increase in price/mix.
Net sales in our Other segment declined $6.3 million, or 18%, to $29.0 million. Volume declined 20% and price/mix increased 2%. The decline was driven by lower volume in our vegetable business, reflecting the negative effect of the extreme summer heat on the yield and quality of the vegetable crops.
Gross Profit and Product Contribution Margin
Gross profit increased $24.3 million, or 12%, to $221.0 million, as the benefits from higher price/mix more than offset the impact of higher manufacturing and distribution costs on a per-pound basis, as well as lower sales volumes. The higher costs per pound primarily reflected double-digit cost inflation from key inputs, particularly raw materials such as edible oils, ingredients such as grains and starches used in product coatings, and raw potatoes, as well as higher transportation, packaging, and labor costs. The increase in costs per pound also reflected the effect of labor shortages on production run-rates, as well as lower raw potato utilization rates related to the poor crop harvested in fall 2021. The increase in per pound costs was partially offset by supply chain productivity savings. The increase in gross profit also included a $1.7 million increase in unrealized mark-to-market adjustments associated with commodity hedging contracts, which includes a $3.6 million gain in the third quarter, compared with a $1.9 million gain related to these items in the prior year quarter.
Lamb Weston’s overall product contribution margin, defined as gross profit less A&P expenses, increased $26.2 million, or 14%, to $217.5 million. The increase was largely due to higher gross profit (as described above) and a $1.9 million decrease in A&P expenses.
Global segment product contribution margin declined $6.3 million, or 8%, to $73.0 million. Higher manufacturing and distribution costs per pound, as well as lower sales volumes due to limited shipping container availability, more than offset the benefit of favorable price/mix. Global segment cost of sales was $413.9 million, up 4% compared to the third quarter of fiscal 2021, primarily due to higher manufacturing and distribution costs, partially offset by lower sales volumes.
Foodservice segment product contribution margin increased $36.5 million, or 52%, to $106.7 million. Favorable price, volume and mix drove the increase, and were partially offset by higher manufacturing and distribution costs per pound. Foodservice segment cost of sales was $186.7 million, up 26% compared to the third quarter of fiscal 2021, primarily due to higher sales volumes and higher manufacturing and distribution costs.
Retail segment product contribution margin declined $1.5 million, or 5%, to $31.6 million. Lower sales volumes and higher manufacturing and distribution costs per pound drove the decline, partially offset by favorable price/mix and a $1.6 million decrease in A&P expenses. Retail segment cost of sales was $110.6 million, a 13% decline compared to the third quarter of fiscal 2021, primarily due to higher manufacturing and distribution costs, partially offset by lower sales volumes.
Other segment product contribution margin declined $2.5 million to $6.2 million in the third quarter of fiscal 2022, as compared to $8.7 million in the third quarter of fiscal 2021. These amounts include a $2.8 million gain related to
23
Table of Contents
unrealized mark-to-market adjustments and realized settlements associated with commodity hedging contracts reported in the Other segment in fiscal 2022, and a $4.3 million gain related to the contracts in fiscal 2021. Excluding these mark-to-market adjustments and realized settlements, Other segment product contribution margin declined $1.0 million, largely due to higher manufacturing costs and lower sales volumes in our vegetable business.
Selling, General and Administrative Expenses
SG&A declined $8.9 million to $87.2 million in the third quarter of fiscal 2022, as compared to $96.1 million in the third quarter of fiscal 2021, primarily due to lower consulting expenses associated with improving the Company’s commercial and supply chain operations, lower compensation and benefits expense, and a $1.9 million decrease in A&P expenses. The decline in SG&A was partially offset by higher information technology infrastructure costs, including expenses related to planning and designing of the Company’s new ERP system, as well as unfavorable foreign exchange expense. Approximately $2 million of the ERP-related expenses recognized in the quarter consisted primarily of consulting expenses that will not continue after the Company implements its new ERP system, compared to approximately $1 million of ERP-related expenses in the prior year quarter.
Interest Expense, Net
Compared with the prior year quarter, interest expense, net decreased $3.5 million to $25.8 million, reflecting a lower weighted average interest rate after our redemption and refinancing in the second quarter of fiscal 2022 of our previously outstanding senior notes due in 2024 and 2026. For more information see “Liquidity and Capital Resources” in this MD&A.
Income Tax Expense
Income tax expense for the third quarter of fiscal 2022 and 2021 was $31.1 million and $16.3 million, respectively. The effective income tax rate (calculated as the ratio of income tax expense to pre-tax income, inclusive of equity method investment earnings) was 22.6% and 19.8% for the third quarter of fiscal 2022 and 2021, respectively. The effective tax rate varies from the U.S. statutory tax rate of 21%, principally due to the impact of U.S. state taxes, foreign taxes, permanent differences, and discrete items.
Equity Method Investment Earnings
We conduct business through unconsolidated joint ventures in Europe, the U.S., and South America and include our share of the earnings based on our economic ownership interest in them. Our share of earnings from our equity method investments was $29.7 million and $11.1 million for the third quarter of fiscal 2022 and 2021, respectively. Equity method investment earnings included a $19.6 million unrealized gain related to mark-to-market adjustments associated with currency and commodity hedging contracts in the third quarter, compared to a $2.2 million unrealized gain related to these items in the prior year quarter. The increase in our mark-to-market adjustments in the third quarter of fiscal 2022 primarily relates to changes in the value of natural gas derivatives at Lamb-Weston/Meijer as commodity markets in Europe have experienced significant volatility.
Excluding the mark-to-market adjustments, earnings from equity method investments increased $1.2 million compared to the prior year period. The increase reflects the benefit of favorable price/mix and higher sales volumes, largely offset by input cost inflation and higher manufacturing and distribution costs in both Europe and the U.S.
24
Table of Contents
Thirty-Nine Weeks Ended February 27, 2022 compared to Thirty-Nine Weeks Ended February 28, 2021
Net Sales, Gross Profit, and Product Contribution Margin
Thirty-Nine Weeks Ended
February 27,
February 28,
%
(in millions)
2022
2021
Inc/(Dec)
Segment net sales
Global
$
1,505.8
$
1,401.9
7%
Foodservice
929.8
697.3
33%
Retail
418.7
457.1
(8%)
Other
91.5
107.1
(15%)
$
2,945.8
$
2,663.4
11%
Segment product contribution margin
Global
$
196.5
$
249.8
(21%)
Foodservice
307.5
243.7
26%
Retail
67.8
99.0
(32%)
Other
(6.6)
32.4
(120%)
565.2
624.9
(10%)
Add: Advertising and promotion expenses
12.6
9.1
38%
Gross profit
$
577.8
$
634.0
(9%)
Net Sales
Compared to the prior year period, Lamb Weston’s net sales increased $282.4 million, or 11%, to $2,945.8 million. Price/mix increased 7% and volume increased 4%. Product and freight pricing actions across each of our business segments, to offset inflation, drove the increase in price/mix. The ongoing recovery in demand for frozen potato products in our restaurant and foodservice channels drove the increase in sales volumes. In the prior year period, demand was affected by reduced shipments related to government-imposed social restrictions on restaurant traffic. While restaurant demand has essentially returned to pre-pandemic levels, our sales volume growth in the current year period has been tempered by our inability to fully serve customer demand due to widespread industry supply chain constraints, including manufacturing labor and commodities shortages, that resulted in lower production run-rates and throughput in our factories, as well as limited shipping container availability.
Global segment net sales increased $103.9 million, or 7%, to $1,505.8 million. Price/mix increased 5% and volume increased 2%. The benefit of domestic and international product and freight pricing actions to offset inflation, as well as favorable mix, drove the increase in price/mix. Strong growth in shipments to large QSR and casual dining restaurant chain customers in the U.S. drove the increase in sales volumes. While demand in most of our key international markets was solid, export sales volumes declined as a result of limited shipping container availability and disruptions to ocean freight networks.
Foodservice segment net sales increased $232.5 million, or 33%, to $929.8 million. Volume increased 23% and price/mix increased 10%. Solid demand at small and regional chain restaurants, as well as independently-owned restaurants, drove the increase in sales volumes. Shipments to non-commercial customers also increased versus the prior year period, but remained below pre-pandemic levels. The segment’s overall volume growth was tempered by our inability to fully serve customer demand due to widespread industry supply chain constraints that resulted in lower production run-rates and throughput in our factories. The increase in price/mix largely reflected the benefits of product and freight pricing actions, as well as favorable mix.
Retail segment net sales declined $38.4 million, or 8%, to $418.7 million. Volume declined 14% while price/mix increased 6%. The sales volume decline primarily reflects lower shipments of private label products resulting from incremental losses of certain low-margin business. Branded product sales volumes were well above pre-pandemic levels,
25
Table of Contents
but were down versus the prior year period because of our inability to fully serve customer demand due to widespread industry supply chain constraints that resulted in lower production run-rates and throughput in our factories. The increase in price/mix was largely driven by product and freight pricing actions to offset inflation, as well as favorable mix.
Net sales in our Other segment declined $15.6 million, or 15%, to $91.5 million. Volume declined 23% and price/mix increased 8%. The decline primarily reflects lower volume in our vegetable business, reflecting the negative effect of the extreme summer heat on the yield and quality of the vegetable crops.
Gross Profit and Product Contribution Margin
Gross profit declined $56.2 million, or 9%, to $577.8 million, as higher manufacturing and distribution costs on a per-pound basis more than offset the benefits from higher price/mix and increased sales volumes. The higher costs per pound predominantly reflected double-digit cost inflation from key inputs, particularly edible oils; transportation; packaging; and ingredients, such as grains and starches used in product coatings. The increase in costs per pound also reflected the effect of labor and commodities shortages on production run-rates, as well as lower raw potato utilization rates due to the poor crop harvested in fall 2021. The increase in per pound costs was partially offset by supply chain productivity savings. The decline in gross profit also included a $21.1 million decrease in unrealized mark-to-market adjustments associated with commodity hedging contracts, which includes a $9.2 million loss in the first three quarters of fiscal 2022, compared with an $11.9 million gain related to these items in the first three quarters of fiscal 2021.
Lamb Weston’s overall product contribution margin declined $59.7 million, or 10%, to $565.2 million. The decline was largely due to lower gross profit (as described above) and a $3.5 million increase in A&P expenses.
Global segment product contribution margin declined $53.3 million, or 21%, to $196.5 million. Higher manufacturing and distribution costs per pound more than offset the benefit of favorable price/mix and higher sales volumes. Global segment cost of sales was $1,306.4 million, up 14% compared to the first three quarters of fiscal 2021, primarily due to higher manufacturing and distribution costs and higher sales volumes.
Foodservice segment product contribution margin increased $63.8 million, or 26%, to $307.5 million. Favorable price/mix and higher sales volumes drove the increase, and was partially offset by higher manufacturing and distribution costs per pound. Foodservice segment cost of sales was $619.0 million, up 37% compared to the first three quarters of fiscal 2021, primarily due to higher sales volumes and higher manufacturing and distribution costs.
Retail segment product contribution margin declined $31.2 million, or 32%, to $67.8 million. Higher manufacturing and distribution costs per pound, lower sales volumes and a $2.3 million increase in A&P expenses, drove the decline. Retail segment cost of sales was $344.7 million, a decline of 3% compared to the first three quarters of fiscal 2021, primarily due to lower sales volumes and higher manufacturing and distribution costs.
Other segment product contribution margin declined $39.0 million to a loss of $6.6 million in the first three quarters of fiscal 2022, as compared to $32.4 million of income in the first three quarters of fiscal 2021. These amounts include a $14.1 million loss related to unrealized mark-to-market adjustments and realized settlements associated with commodity hedging contracts reported in the Other segment in fiscal 2022, and a $16.3 million gain related to the contracts in fiscal 2021. Excluding these mark-to-market adjustments and realized settlements, Other segment product contribution margin declined $8.6 million, largely due to higher manufacturing costs and lower sales volumes in our vegetable business.
Selling, General and Administrative Expenses
SG&A increased $11.3 million to $269.4 million in the first three quarters of fiscal 2022, as compared to $258.1 million in the first three quarters of fiscal 2021, primarily due to investments to improve our information technology and telecommunications infrastructure; expenses largely related to employee recruiting, retention, and temporary labor; a $3.5 million increase in A&P expenses to support new product launches; and higher sales commissions associated with increased sales volumes. The increase in SG&A was partially offset by lower compensation and benefits expense. SG&A included approximately $8 million of ERP-related costs in the first three quarters of fiscal 2022, as compared to
26
Table of Contents
approximately $7 million in the first three quarters of fiscal 2021. In both periods, these costs consisted primarily of consulting expenses that will not continue after we implement the new ERP system.
Interest Expense, Net
Compared with the first three quarters of fiscal 2021, interest expense, net increased $46.5 million to $136.1 million. The increase reflects a $53.3 million ($40.5 million after-tax) loss on extinguishment of debt associated with the redemption of our previously outstanding senior notes due in 2024 and 2026, primarily offset by a lower weighted average interest rate. For more information see “Liquidity and Capital Resources” in this MD&A.
Income Tax Expense
Income tax expense for the first three quarters of fiscal 2022 and 2021 was $49.4 million and $76.2 million, respectively. The effective income tax rate (calculated as the ratio of income tax expense to pre-tax income, inclusive of equity method investment earnings) was 22.6% and 23.2% for the first three quarters of fiscal 2022 and 2021, respectively. The effective tax rate varies from the U.S. statutory tax rate of 21%, principally due to the impact of U.S. state taxes, foreign taxes, permanent differences, and discrete items.
Equity Method Investment Earnings
Our share of earnings from our equity method investments was $46.0 million and $42.2 million for the first three quarters of fiscal 2022 and 2021, respectively. Equity method investment earnings included a $27.5 million unrealized gain related to mark-to-market adjustments associated with currency and commodity hedging contracts in the first three quarters of fiscal 2022, compared to a $6.8 million unrealized gain related to these items in the first three quarters of fiscal 2021. The increase in mark-to-market adjustments in the first three quarters of fiscal 2022 primarily relates to changes in the value of natural gas derivatives at Lamb-Weston/Meijer as commodity markets in Europe have experienced significant volatility.
Excluding the mark-to-market adjustments, earnings from equity method investments declined $16.9 million compared to the first three quarters of fiscal 2021. The earnings decline largely reflects input cost inflation and higher manufacturing costs in Europe and the U.S.
Liquidity and Capital Resources
Sources and Uses of Cash
We ended the first three quarters of fiscal 2022 in a strong financial position with $428.6 million of cash and cash equivalents and $994.6 million of availability under our revolving credit facility, net of letters of credit. During the first three quarters of fiscal 2022, we lowered the interest rates and extended the maturities on $1,670.0 million of our outstanding debt (see Note 9, Debt and Financing Obligations, of the Condensed Notes to Consolidated Financial Statements in “Part I, Item 1. Financial Statements” of this report) and amended our revolving credit facility to increase its capacity to $1.0 billion and extend its maturity date to August 11, 2026. At the end of the first three quarters of fiscal 2022, no borrowings were outstanding under the amended revolving credit facility.
While we expect the near-term impact of the pandemic on costs to remain volatile, we believe we have sufficient liquidity to meet projected capital expenditures, service existing debt and meet working capital requirements for at least the next 12 months with current cash balances and cash from operations, supplemented as necessary by available borrowings under our currently undrawn revolving credit facility.
27
Table of Contents
Cash Flows
Below is a summary table of our cash flows, followed by a discussion of the sources and uses of cash through operating, investing, and financing activities:
Thirty-Nine Weeks Ended
February 27,
February 28,
(in millions)
2022
2021
Net cash flows provided by (used for):
Operating activities
$
174.0
$
374.8
Investing activities
(226.2)
(106.2)
Financing activities
(302.2)
(919.9)
(354.4)
(651.3)
Effect of exchange rate changes on cash and cash equivalents
(0.5)
1.6
Net decrease in cash and cash equivalents
$
(354.9)
$
(649.7)
Operating Activities
In the first three quarters of fiscal 2022, cash provided by operating activities decreased $200.8 million to $174.0 million, compared with $374.8 million in the same period a year ago. The decrease related to $171.3 million of cash used for unfavorable changes in working capital and a $29.5 million decrease in income from operations, adjusted for non-cash income and expenses. Unfavorable changes in working capital primarily related to a decrease in accounts payable primarily due to timing, higher finished goods inventories due to increased input costs, and global disruption in freight networks, which included limited shipping container availability and fewer on-time carrier pick-ups at our warehouses, and an increase in receivables attributable to higher sales at the end of the first three quarters of fiscal 2022, compared with the end of the first three quarters of fiscal 2021. Lower income from operations was driven by higher manufacturing and distribution costs on a per pound basis, reflecting double-digit cost inflation for key inputs, the effect of labor shortages on production run-rates, and lower raw potato utilization rates. See “Results of Operations” in this MD&A for more information.
Investing Activities
Investing activities used $226.2 million of cash in the first three quarters of fiscal 2022, compared with $106.2 million in the same period in the prior year. The increase primarily relates to our investments in our chopped and formed capacity expansion, our french fry processing line in American Falls, Idaho, and our greenfield french fry processing facility in Ulanqab, Inner Mongolia, China. We expect to use approximately $325 million for capital expenditures, excluding acquisitions, in fiscal 2022.
Financing Activities
During the first three quarters of fiscal 2022, cash used for financing activities decreased $617.7 million to $302.2 million, compared with $919.9 million used during the same period a year ago. During the first three quarters of fiscal 2022, financing activities primarily related to issuing U.S. dollar-denominated senior notes and a RMB-denominated loan facility for combined net proceeds of $1,669.2 million, offset by $1,690.1 million of debt and financing obligation repayments, including cash used to redeem our previously outstanding senior notes due in 2024 and 2026, the payment of $103.0 million of cash dividends to common stockholders, and the payment of an aggregate call premium of $39.6 million relating to redeeming the senior notes due in 2024 and 2026. In addition, we used $133.7 million of cash to repurchase 2,027,891 shares of our common stock at an average price of $62.15 and withheld 116,780 shares from employees to cover income and payroll taxes on equity awards that vested during the period.
During the first three quarters of fiscal 2021, financing activities primarily related to the repayment of $498.8 million of short-term borrowings, $297.6 million of debt and financing obligations repayments, which includes the repayment of the $271.9 million term loan facility that was due in November 2021, and the payment of $100.9 million of cash dividends to common stockholders. In addition, we repurchased 164,678 shares of our common stock at an average
28
Table of Contents
price of $77.04 and withheld 162,930 shares from employees to cover income and payroll taxes on equity awards that vested during the period.
For more information about our debt, interest rates, maturity dates, and covenants, see Note 9, Debt and Financing Obligations, of the Condensed Notes to Consolidated Financial Statements in “Part I, Item 1. Financial Statements” of this report and Note 8, Debt and Financing Obligations of the Notes to Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” of the Form 10-K. At February 27, 2022, we were in compliance with the financial covenant ratios and other covenants contained in our credit agreements.
Obligations and Commitments
There have been no material changes to the contractual obligations disclosed in “Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Form 10-K.
Non-GAAP Financial Measures
To supplement the financial information included in this report, we have presented product contribution margin on a consolidated basis, Adjusted EBITDA, and Adjusted EBITDA including unconsolidated joint ventures, each of which is considered a non-GAAP financial measure.
Product contribution margin is one of the primary measures reported to our chief operating decision maker for purposes of allocating resources to our segments and assessing their performance. Product contribution margin represents net sales less cost of sales and A&P expenses. Product contribution margin includes A&P expenses because those expenses are directly associated with the performance of our segments. Our management also uses Adjusted EBITDA and Adjusted EBITDA including unconsolidated joint ventures to evaluate our performance excluding the impact of certain non-cash charges and other special items in order to have comparable financial results to analyze changes in our underlying business between reporting periods. We include these non-GAAP financial measures because management believes they provide useful information to investors in that they provide for greater transparency with respect to supplemental information used by management in its financial and operational decision making. We believe that the presentation of these non-GAAP financial measures, when used in conjunction with GAAP financial measures, is a useful financial analysis tool that can assist investors in assessing our operating performance and underlying prospects. These non-GAAP financial measures should be viewed in addition to, and not as alternatives for, financial measures prepared in accordance with GAAP. These measures are not a substitute for their comparable GAAP financial measures, such as gross profit or net income (loss), and there are limitations to using non-GAAP financial measures. These non-GAAP financial measures may differ from similarly titled non-GAAP financial measures presented by other companies, and other companies may not define these non-GAAP financial measures the same way.
See “Results of Operations – Thirteen Weeks Ended February 27, 2022 compared to Thirteen Weeks Ended February 28, 2021 – Net Sales, Gross Profit, and Product Contribution Margin” and “Results of Operations – Thirty-Nine Weeks Ended February 27, 2022 compared to Thirty-Nine Weeks Ended February 28, 2021 – Net Sales, Gross Profit, and Product Contribution Margin” above for a reconciliation of product contribution margin on a consolidated basis to gross profit.
29
Table of Contents
The following table reconciles net income to Adjusted EBITDA and Adjusted EBITDA including unconsolidated joint ventures:
Thirteen Weeks Ended
Thirty-Nine Weeks Ended
February 27,
February 28,
February 27,
February 28,
(in millions)
2022
2021
2022
2021
Net income
$
106.6
$
66.1
$
168.9
$
252.3
Equity method investment earnings
(29.7)
(11.1)
(46.0)
(42.2)
Interest expense, net
25.8
29.3
136.1
89.6
Income tax expense
31.1
16.3
49.4
76.2
Income from operations
133.8
100.6
308.4
375.9
Depreciation and amortization
46.6
46.3
138.8
138.5
Adjusted EBITDA
180.4
146.9
447.2
514.4
Unconsolidated Joint Ventures
Equity method investment earnings
29.7
11.1
46.0
42.2
Interest expense, income tax expense, and depreciation and
amortization included in equity method investment earnings
9.5
9.1
30.7
25.5
Add: Adjusted EBITDA from unconsolidated joint ventures
39.2
20.2
76.7
67.7
Adjusted EBITDA including unconsolidated joint ventures
$
219.6
$
167.1
$
523.9
$
582.1
Off-Balance Sheet Arrangements
There have been no material changes to the off-balance sheet arrangements disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the Form 10-K.
Critical Accounting Policies and Estimates
A discussion of our critical accounting policies and estimates can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in the Form 10-K. There were no material changes to these critical accounting policies and estimates during the first three quarters of fiscal 2022.
New and Recently Adopted Accounting Pronouncements
For a list of our new and recently adopted accounting pronouncements, see Note 1, Nature of Operations and Summary of Significant Accounting Policies, of the Condensed Notes to Consolidated Financial Statements in “Part I, Item 1. Financial Statements” of this report.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.