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 28, 2023 (the “Form 10-K”), which we filed with the United States (“U.S.”) Securities and Exchange Commission (“SEC”) on July 25, 2023.
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,” “would,” “believe,” “deliver,” “counter,” “manage,” “anticipate,” “drive,” “leverage,” “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 expenditures and investments, pricing actions, cash flows, liquidity, dividends, enterprise resource planning (“ERP”) system implementation, integration of our former European joint venture, Lamb-Weston/Meijer v.o.f. (“LW EMEA”), and business and financial outlook and prospects, as well as inflation, our industry, and global economic conditions. 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 these forward-looking statements and 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 and other commodities; labor shortages and other operational challenges; an uncertain general economic environment, including inflationary pressures and recessionary concerns, any of which could adversely impact our business, financial condition or results of operations, including the demand and prices for our products; risks associated with integrating acquired businesses, including LW EMEA; levels of 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 operate; political and economic conditions of the countries in which we conduct business and other factors related to our international operations; disruptions in the global economy caused by conflicts such as the war in 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; disruption of our access to export mechanisms; risks associated with other possible acquisitions; our debt levels; changes in our relationships with our growers or significant customers; actions of governments and regulatory factors affecting our businesses; 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. 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”) is a leading global producer, distributor, and marketer of value-added frozen potato products. We 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 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.
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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 (Adjusted EBITDA) that is prepared using non-GAAP financial measures. Refer to “Non-GAAP Financial Measures” below for the definition of Adjusted EBITDA, and a reconciliation of this non-GAAP financial measure to its most directly comparable GAAP financial measure, net income. For more information, refer to the “Results of Operations” and “Non-GAAP Financial Measures” sections below.
Executive Summary
In the first quarter of fiscal 2024, we drove solid sales growth and earnings growth, reflecting: the carryover benefit of pricing actions taken in the prior year to counter input cost inflation; incremental sales and earnings from the acquisitions of the remaining equity interest in LW EMEA, our former joint venture in Europe, and an additional equity interest in Lamb Weston Alimentos Modernos S.A. (“LWAMSA”), our joint venture in Argentina; the timing of trade spending in North America; favorable mix; and supply chain productivity savings. Sales volumes, excluding the benefit of acquisitions, declined, primarily due to our decisions to strategically manage our customer and product mix by exiting certain lower-priced and lower-margin business. Volume elasticities remained low. Overall demand for frozen potato products in the North America and most key international markets remained solid, although restaurant traffic trends continued to be soft compared to pre-pandemic traffic levels as consumers faced persistent inflation, including for food purchased away from home.
Gross profit in the first quarter increased as favorable price/mix, including benefits from the timing of trade spending, more than offset higher input and manufacturing costs on a per pound basis as well as the impact of lower sales volumes. Incremental earnings from the consolidation of the financial results of LW EMEA also contributed to the increase. The gross profit increase was partially offset by higher selling, general and administrative (“SG&A”) expenses, resulting in an increase in income from operations. Higher income from operations drove the increase in net income and diluted EPS.
In the first quarter of fiscal 2024, we generated net cash from operating activities of $334.6 million, up $142.5 million versus the prior year quarter, due to higher earnings, partially offset by increased working capital. We ended the first quarter with $163.3 million of cash and cash equivalents and a $1.0 billion undrawn U.S. revolving credit facility. In addition, we returned $140.8 million to our common stockholders, including $100.0 million of share repurchases and $40.8 million in cash dividends.
Outlook
In fiscal 2024, we expect to deliver net sales and earnings growth, and to benefit from incremental sales and earnings during the first three quarters of the fiscal year attributable to the consolidation of the financial results of LW EMEA, as compared to the first three quarters of fiscal 2023. In addition to the incremental sales related to the consolidation of LW EMEA, we expect our net sales growth to be largely driven by pricing actions to counter input cost inflation, and expect sales volumes will be pressured by our decisions to strategically manage our customer and product mix by exiting certain lower-priced and lower-margin business. We also anticipate that demand for our products in the near term may be tempered by softer restaurant traffic trends in North America and other key markets as our customers and consumers both respond to challenging macroeconomic environments.
We expect our earnings growth to be largely driven by sales and gross profit growth, and that the rate of input cost inflation, driven largely by higher potato costs, will, in aggregate, moderate as compared to fiscal 2023 inflation rates. We anticipate that the increase in gross profit will be partially offset by higher SG&A, reflecting: incremental expense attributable to the consolidation of the financial results of LW EMEA; increased investments to upgrade our information systems and ERP infrastructure; non-cash amortization of intangible assets associated with the acquisition of the remaining equity interest in LW EMEA as well as prior investments in our ERP infrastructure; and higher compensation and benefits expense due to increased employee headcount.
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We believe in the long-term growth outlook for the frozen potato category and that Lamb Weston is well-positioned to drive sustainable, profitable growth, and to better serve customers around the world as we seek to leverage commercial and operational benefits from our acquisition of the remaining equity interest in LW EMEA (the “LW EMEA Acquisition”), as well as the benefits we expect from our previously announced capacity expansion investments in China, the U.S., Argentina, and the Netherlands.
Results of Operations
Effective May 29, 2023, to align with our expanded global footprint following the completion of our acquisition of the remaining 50% interest in LW EMEA, management, including our chief executive officer (who is our chief operating decision maker), began managing operations in two business segments based on management’s change to the way it monitors performance, aligns strategies, and allocates resources. As a result of this change, we now have two operating segments, each of which is a reportable segment: North America and International. We report net sales and Adjusted EBITDA by segment and on a consolidated basis, which are the primary measures reported to our chief operating decision maker for purposes of allocating resources to our segments and assessing their performance. Adjusted EBITDA is a non-GAAP financial measure. For additional information on our reportable segments, Segment Adjusted EBITDA, and Adjusted EBITDA, see Note 12, Segments, of the Condensed Notes to Consolidated Financial Statements in “Part I, Item 1. Financial Statements” of this report and “Non-GAAP Financial Measures” below. Prior period segment data has been retrospectively adjusted to conform with current period classification.
Thirteen Weeks Ended August 27, 2023 compared to Thirteen Weeks Ended August 28, 2022
Net Sales and Segment Adjusted EBITDA
Thirteen Weeks Ended
August 27,
August 28,
%
(in millions, except percentages)
2023
2022
Increase
Segment net sales
North America
$
1,135.4
$
955.6
19%
International
529.9
170.0
212%
$
1,665.3
$
1,125.6
48%
Segment Adjusted EBITDA
North America
$
379.4
$
231.8
64%
International
89.6
33.1
171%
Net Sales
Compared to the prior year quarter, net sales for the first quarter of fiscal 2024 increased $539.7 million, or 48%, to $1,665.3 million, and included $374.9 million of incremental sales attributable to the consolidation of the financial results of (1) LW EMEA, following the completion of the LW EMEA Acquisition in February 2023, and (2) LWAMSA, following our acquisition in July 2022 of an additional 40% equity interest in LWAMSA (the “LWAMSA Acquisition” and, together with the LW EMEA Acquisition, the “Acquisitions”).
Net sales, excluding the incremental sales attributable to the Acquisitions, grew 15% versus the prior year quarter. Price/mix increased 23%, reflecting the benefit of pricing actions across each of our business segments to counter input and manufacturing cost inflation, the timing of trade spending in North America, and favorable mix, partially offset by lower customer transportation charges. Volume declined 8%, primarily reflecting our decisions to exit certain lower-priced and lower-margin business as we continue to strategically manage customer and product mix. To a lesser extent, inventory destocking by certain customers in international markets and in select U.S. retail channels also pressured volumes. Volume elasticities in response to inflation-based pricing actions across our portfolio have generally been low.
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North America segment net sales, which includes all sales to customers in the U.S., Canada, and Mexico, increased $179.8 million, or 19%, to $1,135.4 million. Price/mix increased 24%, reflecting the carryover benefit of pricing actions taken in fiscal 2023 to counter inflationary pressures, as well as favorable mix, partially offset by lower customer transportation charges. Volume declined 5%, primarily reflecting our decisions to exit certain lower-priced and lower-margin business. To a lesser extent, lower shipments in response to inventory destocking by certain customers also pressured volumes.
International segment net sales, which includes all sales to customers outside of North America, increased $359.9 million, or 212%, to $529.9 million, and included $374.9 million of incremental sales attributable to the Acquisitions. International segment net sales, excluding the incremental sales attributable to the Acquisitions, declined 9%. Price/mix increased 18%, driven by the carryover benefit of pricing actions taken in fiscal 2023 to counter inflationary pressures, as well as favorable mix, partially offset by lower customer transportation charges. Volume declined 27%, primarily reflecting our decisions to exit certain lower-priced and lower-margin business. To a lesser extent, lower shipments in response to inventory destocking by certain customers in several markets in the Asia-Pacific region also pressured volume.
Gross Profit
Gross profit increased $226.2 million, or 83%, to $499.5 million, and included $22.5 million of costs ($16.7 million after-tax, or $0.11 per share) associated with the sale of inventory stepped-up to fair value in the LW EMEA Acquisition, and a $31.7 million ($23.8 million after-tax, or $0.16 per share) unrealized gain related to mark-to-market adjustments associated with commodity hedging contracts. The prior year quarter included a $4.0 million ($3.0 million after-tax, or $0.02 per share) unrealized loss related to mark-to-market adjustments associated with commodity hedging contracts. We have identified LW EMEA integration and acquisition-related items as items impacting comparability, and all unrealized mark-to-market gains and losses related to commodity derivatives as adjustments, in the current and prior year quarters.
Excluding unrealized mark-to-market commodity gains and losses and items impacting comparability, gross profit increased $213.0 million, driven primarily by: benefits from pricing actions, which more than offset the impact of higher costs on a per pound basis and lower sales volumes; the timing of trade spending in North America; and incremental earnings attributable to the consolidation of the financial results of LW EMEA. The higher costs per pound reflected mid-to-high-single-digit cost inflation for key inputs, including: raw potatoes, labor, ingredients such as grains and starches used in product coatings, and energy. The increase in per pound costs was partially offset by lower costs for edible oils and transportation.
Selling, General and Administrative Expenses
SG&A increased $59.9 million to $176.2 million in the first quarter of fiscal 2024, and included $4.0 million of LW EMEA integration and acquisition-related expenses ($3.0 million after-tax, or $0.02 per share), $4.4 million ($3.3 million after-tax, or $0.02 per share) of unrealized losses related to mark-to-market adjustments associated with currency hedging contracts, and $7.4 million ($5.5 million after-tax, or $0.04 per share) of foreign currency exchange losses. The prior year quarter included $1.0 million ($0.7 million after-tax, with no per share impact) of foreign currency exchange losses. Excluding these items, SG&A increased $45.1 million to $160.4 million, primarily due to incremental expenses attributable to the consolidation of the financial results of LW EMEA, and higher expenses related to improving our information systems and ERP infrastructure.
Segment Adjusted EBITDA
North America Segment Adjusted EBITDA increased $147.6 million to $379.4 million. The carryover benefit of pricing actions, the timing of trade spending, and favorable mix drove the increases, which were partially offset by higher costs per pound and the impact of lower volumes.
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International Segment Adjusted EBITDA increased $56.5 million to $89.6 million, up 171 percent and excluded $22.5 million of costs ($16.7 million after-tax, or $0.11 per share) associated with the sale of inventory stepped-up to fair value in the LW EMEA Acquisition. Incremental earnings from the consolidation of the financial results of LW EMEA and favorable price/mix drove the increases, which were partially offset by higher costs per pound and the impact of lower volumes.
Interest Expense, Net
Compared with the prior year quarter, interest expense, net increased $4.7 million to $30.7 million, reflecting the impact of higher total debt outstanding and higher interest rates on our floating rate debt, partially offset by higher capitalized interest related to our manufacturing expansion projects and interest income.
Income Tax Expense
Income tax expense for the first quarter of fiscal 2024 and 2023 was $69.9 million and $73.7 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 22.9% and 24.1% for the first quarter of fiscal 2024 and 2023, respectively. Excluding foreign currency exchange and unrealized mark-to-market derivative gains and losses and items impacting comparability, our effective tax rate for the first quarter of fiscal 2024 and 2023 was 23.1% and 25.0%, 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 and currency, permanent differences, and discrete items.
Equity Method Investment Earnings
Equity method investment earnings from unconsolidated joint ventures were $12.1 million and $174.6 million for the first quarter of fiscal 2024 and 2023, respectively. The results in the current quarter include earnings associated with our 50% interest in Lamb Weston/RDO Frozen, an unconsolidated joint venture in the U.S., while results in the prior year quarter also included earnings associated with our 50% interests in LW EMEA and LWAMSA. The results in the prior year quarter include a $144.5 million unrealized gain related to mark-to-market adjustments associated with currency and commodity hedging contracts ($107.2 million after-tax, or $0.74 per share), and a $15.1 million gain (before and after-tax, or $0.10 per share) recognized in connection with the LWAMSA Acquisition, which related to remeasuring our previously held 50% ownership interest to fair value.
Excluding these items, equity method investment earnings declined $2.9 million compared to the prior year quarter, largely due to LW EMEA earnings being included in the prior year quarter.
Liquidity and Capital Resources
Sources and Uses of Cash
As of August 27, 2023, we had $163.3 million of cash and cash equivalents and a $1.0 billion undrawn U.S. revolving credit facility. We believe we have sufficient liquidity to meet our business requirements for at least the next 12 months. Cash generated by operations, supplemented by our cash and cash equivalents and availability under our credit facilities, is our primary source of liquidity for funding business requirements. Our funding requirements include capital expenditures for announced manufacturing expansions in China, Idaho, the Netherlands, and Argentina, as well as capital investments to upgrade information systems and ERP infrastructure, working capital requirements, and dividends.
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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:
Thirteen Weeks Ended
August 27,
August 28,
(in millions)
2023
2022
Net cash flows provided by (used for):
Operating activities
$
334.6
$
192.1
Investing activities
(304.8)
(166.9)
Financing activities
(171.7)
(63.5)
(141.9)
(38.3)
Effect of exchange rate changes on cash and cash equivalents
0.4
(1.4)
Net decrease in cash and cash equivalents
(141.5)
(39.7)
Cash and cash equivalents, beginning of period
304.8
525.0
Cash and cash equivalents, end of period
$
163.3
$
485.3
Operating Activities
In the first quarter of fiscal 2024, cash provided by operating activities increased $142.5 million to $334.6 million, compared with $192.1 million in the same period a year ago. The increase related to a $169.1 million increase in income from operations, adjusted for non-cash income and expenses, partially offset by $26.6 million of cash used for unfavorable changes in working capital, primarily related to the timing of incentive accruals and accounts payable payments. See “Results of Operations” in this MD&A for more information related to the increase in income from operations.
Investing Activities
Investing activities used $304.8 million of cash in the first quarter of fiscal 2024, compared with $166.9 million in the same period in the prior year. The increase primarily relates to our investments to expand our french fry and chopped and formed capacity and other facility modernization efforts in American Falls, Idaho; and the construction of a greenfield french fry processing facility in Ulanqab, Inner Mongolia, China. We also used $37.4 million to upgrade our information systems and ERP infrastructure. We expect to use approximately $800 million to $900 million in fiscal 2024 as we continue construction of our capacity expansion efforts in China, Idaho, the Netherlands and Argentina, as well as capital investments to upgrade our information systems and ERP infrastructure.
Financing Activities
During the first quarter of fiscal 2024, we used $113.5 million of cash to repurchase 992,365 shares of our common stock at an average price of $100.77 per share and withheld 132,067 shares from employees to cover income and payroll taxes on equity awards that vested during the period. In addition, we paid $40.8 million of cash dividends to common stockholders and repaid $18.9 million of short-term borrowings and $13.7 million of debt and financing obligations. These financing uses were partially offset by $15.1 million of borrowings on other credit facilities.
In the first quarter of fiscal 2023, cash used for financing activities primarily related to additional borrowings under our RMB-denominated loan facility, which generated net proceeds of $13.8 million, offset by $8.0 million of debt and financing obligation repayments. We also paid $35.3 million of cash dividends to common stockholders. In addition, we used $28.4 million of cash to repurchase 404,476 shares of our common stock at an average price of $70.11 and withheld 77,756 shares from employees to cover income and payroll taxes on equity awards that vested during the period.
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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 August 27, 2023, 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 Adjusted EBITDA, which is considered a non-GAAP financial measure. Management uses this non-GAAP financial measure to assist in analyzing what management views as our core operating performance for purposes of business decision making. Management believes that presenting this non-GAAP financial measure provides investors with useful supplemental information because it (i) provides meaningful supplemental information regarding financial performance by excluding foreign currency exchange and unrealized mark-to-market derivative gains and losses and items affecting comparability between periods, (ii) permits investors to view performance using the same tools that management uses to budget, make operating and strategic decisions, and evaluate historical performance, and (iii) otherwise provides supplemental information that may be useful to investors in evaluating our financial results. In addition, we believe that the presentation of this non-GAAP financial measure, when considered together with the most directly comparable GAAP financial measure and the reconciliation to this GAAP financial measure, provides investors with additional tools to understand the factors and trends affecting our underlying business than could be obtained absent these disclosures.
The non-GAAP financial measure presented in this report should be viewed in addition to, and not as an alternative for, financial measures prepared in accordance with GAAP that are also presented in this report. This measure is not a substitute for its comparable GAAP financial measure, net income, and there are limitations to using non-GAAP financial measures. For example, the non-GAAP financial measure presented in this report may differ from similarly titled non-GAAP financial measures presented by other companies, and other companies may not define this non-GAAP financial measure the same way we do.
The following table reconciles net income to Adjusted EBITDA:
Thirteen Weeks Ended
August 27,
August 28,
(in millions)
2023
2022
Net income
$
234.8
$
231.9
Interest expense, net
30.7
26.0
Income tax expense
69.9
73.7
Income from operations including equity method investment earnings
335.4
331.6
Depreciation and amortization (a)
70.8
57.6
Unrealized derivative (gains) losses
(27.3)
4.0
Unconsolidated joint venture unrealized derivative gains
—
(144.5)
Foreign currency exchange losses
7.4
1.0
Items impacting comparability:
Inventory step-up from acquisition
22.5
—
Integration and acquisition-related items, net
4.0
—
Gain on acquisition of interest in joint venture
—
(15.1)
Adjusted EBITDA
$
412.8
$
234.6
(a) Depreciation and amortization included interest expense, income tax expense, and depreciation and amortization included in equity method investment earnings of $2.2 million and $8.9 million for the thirteen weeks ended August 27, 2023 and August 28, 2022, respectively.
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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 quarter of fiscal 2024 .
New and Recently Adopted Accounting Pronouncements
There were no accounting pronouncements recently issued that had or are expected to have a material impact on our consolidated financial statements. 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 Notes to Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” included in the Form 10-K.
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