Lamb Weston Holdings, Inc. 10-Q

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 26, 2024 (the “Form 10-K”), which we filed with the United States (“U.S.”) Securities and Exchange Commission (the “SEC”) on July 24, 2024. 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,” “manage,” “reduce,” “remain,” “estimate,” “anticipate,” “drive,” “increase,” “decline,” “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 business and financial outlook and prospects, our plans and strategies and anticipated benefits therefrom, including with respect to the Restructuring Plan (as defined below), expected completion and impacts of restructuring activities and cost-saving or efficiency initiatives, capital expenditures and investments, pricing actions, operational costs, volume growth, cash flows, liquidity, dividends, and inflation, demand for our products, our cost structure, conditions in 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 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: consumer preferences, including restaurant traffic in North America and our international markets, and 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; the availability and prices of raw materials and other commodities; operational challenges; our ability to successfully implement the Restructuring Plan, including achieving the benefits of restructuring activities and cost-saving or efficiency initiatives and possible changes in the size and timing of related charges; difficulties, disruptions or delays in implementing new technology, such as our new enterprise resource planning (“ERP”) system; 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 conflicts in the Middle East and the possible related heightening of our other known risks; the ultimate outcome of litigation or any product recalls or withdrawals; changes in our relationships with our growers or significant customers; 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 integrating acquired businesses, including our former European joint venture, Lamb-Weston/Meijer v.o.f. (“LW EMEA”); risks associated with other possible acquisitions; our debt levels; actions of governments and regulatory factors affecting our businesses; 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. 17 Table of Contents 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”). We have also presented Adjusted EBITDA, Adjusted Gross Profit, and Adjusted Selling, General and Administrative expenses (“SG&A”), each of which is considered a non-GAAP financial measure, to supplement the financial information included in this report. Refer to “Non-GAAP Financial Measures” below for the definitions of Adjusted EBITDA, Adjusted Gross Profit, and Adjusted SG&A, and a reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures, net income, gross profit, or SG&A, as applicable. For more information, refer to the “Results of Operations” and “Non-GAAP Financial Measures” sections below. Executive Summary In a challenging operating environment, we delivered first quarter financial results that were generally in line with our expectations, driven by sequentially improved volume performance, solid price/mix, and strict management of operating costs. Restaurant traffic and frozen potato demand, relative to supply, however, continue to be soft, and we believe it will remain soft through the remainder of fiscal 2025. To drive operational and cost efficiencies and improve cash flows, on October 1, 2024, we announced a restructuring plan (the “Restructuring Plan”) that includes the permanent closure of an older, higher-cost processing facility and the temporary curtailment of certain production lines and schedules in our manufacturing network in North America. Together, we expect these actions will help us better manage our factory utilization rates and ease some of the industry’s current supply-demand imbalance in North America. We also announced actions to reduce operating expenses, including reducing global headcount and eliminating certain unfilled job positions, as well as reducing estimated fiscal 2025 capital expenditures by $100 million. In connection with the Restructuring Plan, we expect to record total pre-tax charges of $200 million to $250 million in fiscal 2025 (most of which will be recorded during the fiscal second quarter), of which we estimate that approximately 80% will be cash and 20% will be non-cash. The charges primarily relate to the costs associated with contracted raw potatoes that will not be used due to production line curtailments, accelerating depreciation of assets, the write-down of inventory and long-lived assets, employee severance and other one-time termination benefits, and other costs. In fiscal 2025, we expect these actions to deliver approximately $55 million of pre-tax savings (approximately $85 million on an annualized basis) and reduce working capital. Outlook Despite a challenging environment, in fiscal 2025, we expect higher sales volumes and improved mix will drive sales growth on a constant currency basis, as compared to fiscal 2024. We expect volume will decline during the first half of fiscal 2025 due to the impact of market share losses and menu price inflation, which we believe will continue to affect global restaurant traffic and demand for frozen potato products. We anticipate that volume will increase in the second half of fiscal 2025 as we lap the prior-year impact of transitioning to our new ERP system and benefit from recent customer contract wins. We expect our earnings will decline as higher manufacturing costs per pound driven by input cost inflation, costs associated with the Restructuring Plan, investments in price and trade to attract and retain volume, and higher depreciation expense associated with our recent capacity expansion efforts will more than offset the benefits of volume growth, improved mix, and cost saving initiatives. We anticipate that input costs, in the aggregate, will continue to rise, but at a more moderate rate as compared to fiscal 2024. We expect that an increase in SG&A will reflect charges associated with the Restructuring Plan, higher performance-based compensation expense, incremental non-cash amortization of prior investments in our ERP infrastructure, inflation, and investments in our information technology infrastructure, and will largely be offset by cost savings from our Restructuring Plan and other cost saving initiatives. We believe the proactive restructuring actions will improve our operating efficiency, profitability, and cash flows, while also helping to position us to continue to make strategic investments to support our customers and create value for our stakeholders over the long-term. 18 Table of Contents Results of Operations Thirteen Weeks Ended August 25, 2024 compared to Thirteen Weeks Ended August 27, 2023 Net Sales and Segment Adjusted EBITDA Thirteen Weeks Ended (in millions, except percentages) August 25, 2024 August 27, 2023 % Increase (Decrease) Segment Net Sales North America $ 1,103.7 $ 1,135.4 (3)% International 550.4 529.9 4% $ 1,654.1 $ 1,665.3 (1)% Segment Adjusted EBITDA North America $ 276.1 $ 379.4 (27)% International 50.5 89.6 (44)% Net Sales Compared to the prior year quarter, net sales for the first quarter of fiscal 2025 declined $11.2 million, or 1%, to $1,654.1 million. Volume declined 3%, largely reflecting the impact of customer share losses, soft restaurant traffic trends, the carryover effect of our decision in the prior year to exit certain lower-priced and lower-margin business in Europe to strategically manage customer and product mix, and the impact of a previously announced voluntary product withdrawal initiated in late fiscal 2024. The volume decline was partially offset by growth in key international markets. Price/mix increased 2%, reflecting the benefit of inflation-driven pricing actions in Europe and North America, and was partially offset by unfavorable channel and product mix, as well as targeted investments in price and trade support to attract and retain volume. North America segment net sales, which includes all sales to customers in the U.S., Canada, and Mexico, declined $31.7 million, or 3%, to $1,103.7 million. Volume declined 4%, largely reflecting the impact of customer share losses and declining restaurant traffic in the U.S. Price/mix increased 1%, reflecting the carryover benefit of inflation-driven pricing actions taken in fiscal 2024 for contracts with large and regional chain restaurant customers, partially offset by unfavorable channel and product mix, as well as targeted investments in price and trade support across all sales channels. International segment net sales, which includes all sales to customers outside of North America, increased $20.5 million, or 4%, to $550.4 million. Volume declined 1%, due to the carryover effect of our decision in the prior year to exit certain lower-priced and lower-margin business in Europe, as well as the impact of the voluntary product withdrawal. The decline was partially offset by volume growth in key international markets outside of Europe. Price/mix increased 5% reflecting pricing actions announced this fiscal year to counter input cost inflation. Gross Profit Gross profit declined $143.5 million versus the prior year quarter to $356.0 million, and included $2.9 million ($2.2 million after-tax, or $0.01 per share) of unrealized gains related to mark-to-market adjustments associated with commodity hedging contracts. The prior year quarter included $31.7 million ($23.8 million after-tax, with $0.16 per share impact) of unrealized gains related to mark-to-market adjustments associated with commodity hedging contracts, and $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 following the completion of our acquisition of the remaining interest in LW EMEA. Adjusted Gross Profit declined $137.2 million versus the prior year quarter to $353.1 million. Higher manufacturing costs per pound, an approximately $39 million loss associated with the voluntary product withdrawal, lower sales volumes, and higher warehouse costs drove the decline, and was partially offset by a net benefit from pricing actions. The higher manufacturing costs per pound largely reflected input cost inflation, which was primarily driven by higher raw 19 Table of Contents potato costs; utilization-related production costs and inefficiencies; and $15.5 million of higher depreciation expense largely associated with our recent capacity expansions in China and the U.S. We do not expect further significant sales or earnings impact from the voluntary product withdrawal during the remainder of fiscal 2025. Selling, General and Administrative Expenses SG&A declined $32.3 million versus the prior year quarter to $143.9 million, and included a gain of $16.6 million (before and after-tax, or $0.12 per share) related to blue chip swap transactions in Argentina (as described below), $0.6 million ($0.5 million after-tax, or $0.01 per share) of foreign currency exchange losses, and $6.0 million ($4.4 million after-tax, or $0.03 per share) of unrealized gains related to mark-to-market adjustments associated with currency hedging contracts. The prior year quarter included $7.4 million ($5.5 million after-tax, or $0.04 per share) of foreign currency exchange losses, $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 $4.0 million of LW EMEA integration and acquisition-related expenses ($3.0 million after-tax, or $0.02 per share). Adjusted SG&A increased $5.5 million versus the prior year quarter to $165.9 million, primarily due to $6.1 million of incremental non-cash amortization and expense related to our new ERP system. The benefit of cost savings initiatives essentially offset inflation and information technology investments. Net Income, Adjusted EBITDA and Segment Adjusted EBITDA Net income declined $107.4 million from the prior year quarter to $127.4 million. Net income in the current quarter included a total net gain of $22.7 million ($24.9 million before tax, or $0.15 per share) for gains resulting from blue chip swap transactions in Argentina, foreign currency exchange losses, and unrealized mark-to-market derivative gains and losses. Net income in the prior year quarter included a total net loss of $4.7 million ($6.6 million before tax, or $0.03 per share) for foreign currency exchange losses, and unrealized mark-to-market derivative gains and losses, and items impacting comparability. Adjusted EBITDA declined $122.9 million from the prior year quarter to $289.9 million, primarily due to lower sales and Adjusted Gross Profit, which includes an approximately $39 million loss associated with the voluntary product withdrawal. North America Segment Adjusted EBITDA declined $103.3 million versus the prior year quarter to $276.1 million. Higher manufacturing costs per pound, an approximately $21 million charge for the voluntary product withdrawal related to products manufactured in North America, and lower sales volumes drove the decline, which was partially offset by a net benefit from pricing actions. International Segment Adjusted EBITDA declined $39.1 million versus the prior year quarter to $50.5 million. An approximately $18 million impact associated with the voluntary product withdrawal and higher manufacturing costs per pound largely drove the decline, which was partially offset by the benefit of inflation-driven pricing actions. Interest Expense, Net Interest expense, net increased $14.5 million versus the prior year quarter to $45.2 million, reflecting the impact of higher total debt outstanding, higher interest rates on our floating rate debt, and less capitalized interest related to our manufacturing expansion projects, net of interest income. Income Tax Expense Income tax expense for the first quarter of fiscal 2025 and 2024 was $50.8 million and $69.9 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 28.5% and 22.9% for the first quarter of fiscal 2025 and 2024, respectively. The effective tax rate varied between periods due to a higher proportion of earnings in our International segment in fiscal 2025, as compared with fiscal 2024, and discrete tax items. Equity Method Investment Earnings Equity method investment earnings from unconsolidated joint ventures were earnings of $11.3 million and $12.1 million for the first quarter of fiscal 2025 and 2024, respectively. The results in the current quarter and prior year quarter 20 Table of Contents reflects earnings associated with our 50% interest in Lamb Weston/RDO Frozen, an unconsolidated potato processing joint venture in Minnesota. Liquidity and Capital Resources Sources and Uses of Cash As of August 25, 2024, we had $120.8 million of cash and cash equivalents, with $1,004.0 million of available liquidity under our global 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 global revolving credit facility , are our primary sources of liquidity for funding our business requirements. Our funding requirements include capital expenditures for announced manufacturing capacity expansions in the Netherlands and Argentina, working capital requirements, and shareholder returns, including cash dividends and repurchases under our share repurchase program. As discussed under “Executive Summary ” in this MD&A, as we implement cost-reduction measures under the Restructuring Plan, we expect reductions in operating expenditures, cost of sales and capital expenditures will drive operational efficiencies and improve cash flows, while helping to position us to continue to fund strategic investments to support our customers. 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 (in millions) August 25, 2024 August 27, 2023 Net cash flows provided by (used for): Operating activities $ 330.2 $ 334.6 Investing activities (335.6) (304.8) Financing activities 52.2 (171.7) 46.8 (141.9) Effect of exchange rate changes on cash and cash equivalents 2.6 0.4 Net increase (decrease) in cash and cash equivalents 49.4 (141.5) Cash and cash equivalents, beginning of period 71.4 304.8 Cash and cash equivalents, end of period $ 120.8 $ 163.3 Operating Activities Cash provided by operating activities declined $4.4 million versus the prior year quarter to $330.2 million. The decline related to a $122.1 million decrease in income from operations, adjusted for non-cash income and expenses, partially offset by $117.7 million of cash increase for favorable changes in working capital, primarily related to no performance-based incentive compensation benefit payments in the first quarter of fiscal 2025, and the timing of accounts payable. See “Results of Operations” in this MD&A for more information related to the increase in income from operations. Investing Activities Investing activities used $335.6 million of cash in the first quarter of fiscal 2025, compared with $304.8 million in the same period in the prior year. Expenditures in both periods primarily related to our investments to expand our french fry capacity and other facility modernization efforts in China, the Netherlands, the U.S., and Argentina. In connection with the Restructuring Plan, we decreased our estimate of capital expenditures in fiscal 2025 by $100 million to $750 million excluding acquisitions, which included pausing the next phase of our ERP build and implementation. Financing Activities During the first quarter of fiscal 2025, net proceeds from short-term borrowings were $203.6 million which were primarily used for general corporate purposes, including, but not limited to, funding capital expenditures and working capital requirements. We used $92.2 million of cash to repurchase 1,412,852 shares of our common stock at an average 21 Table of Contents price of $58.04 per share, and we withheld 178,941 shares from employees to cover income and payroll taxes on equity awards that vested during the period. In addition, we paid $51.7 million in cash dividends to common stockholders and repaid $10.2 million of debt and financing obligations. 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 we 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 our common stockholders and repaid $32.9 million of short-term borrowings and $13.7 million of other debt and financing obligations. These financing uses were partially offset by $15.1 million of borrowings under our credit facilities. 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 6, 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 25, 2024, we were in compliance with the financial covenant ratios and other covenants contained in our debt agreements. Obligations and Commitments On September 27, 2024, we entered into a new $500 million term loan facility, the proceeds of which were used to repay the remaining $225 million balance of our Term A-1 loan facility and $275 million of outstanding borrowings under our global revolving credit facility. Except for these transactions, there have been no other 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. 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 for more information. Non-GAAP Financial Measures To supplement the financial information included in this report, we have presented Adjusted EBITDA, Adjusted Gross Profit, and Adjusted SG&A, each of which is considered a non-GAAP financial measure. Management uses these non-GAAP financial measures to assist in analyzing what management views as our core operating performance for purposes of business decision making. Management believes that presenting these non-GAAP financial measures provide investors with useful supplemental information because they (i) provide meaningful supplemental information regarding financial performance by excluding impacts of foreign currency exchange rates and unrealized mark-to-market derivative gains and losses and other items affecting comparability between periods, (ii) permit investors to view performance using the same tools that management uses to budget, make operating and strategic decisions, and evaluate our core operating performance across periods, and (iii) otherwise provide supplemental information that may be useful to investors in evaluating our financial results. In addition, we believe that the presentation of these non-GAAP financial measures, when considered together with their most directly comparable GAAP financial measure and the reconciliations to those GAAP financial measures, 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 measures presented in this report should be viewed in addition to, and not as alternatives for, financial measures prepared in accordance with GAAP that are also presented in this report. These measures are not substitutes for their comparable GAAP financial measures, such as net income, gross profit, SG&A, or other measures prescribed by GAAP, and there are limitations to using non-GAAP financial measures. For example, the non-GAAP financial measures presented in this report 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 we do. 22 Table of Contents The following table reconciles net income to Adjusted EBITDA: Thirteen Weeks Ended (in millions) August 25, 2024 (a) August 27, 2023 Net income $ 127.4 $ 234.8 Interest expense, net 45.2 30.7 Income tax expense 50.8 69.9 Income from operations including equity method investment earnings 223.4 335.4 Depreciation and amortization (b) 91.4 70.8 Unrealized derivative gains (8.9) (27.3) Foreign currency exchange losses 0.6 7.4 Blue chip swap transaction gains (c) (16.6) — Items impacting comparability: Inventory step-up from acquisition — 22.5 Integration and acquisition-related items, net — 4.0 Adjusted EBITDA $ 289.9 $ 412.8 ___________________________________________ (a) Net income included an approximately $39 million loss related to the voluntary product withdrawal that occurred in the first quarter of fiscal 2025 . (b) Depreciation and amortization included interest expense, income tax expense, and depreciation and amortization included in equity method investment earnings of $2.1 million and $2.2 million for the thirteen weeks ended August 25, 2024 and August 27, 2023, respectively. (c) We enter into blue chip swap transactions to transfer U.S. dollars into and out of Argentina primarily related to funding our announced capacity expansion in Argentina. The blue chip swap rate can diverge significantly from Argentina's official exchange rate. The following tables reconcile gross profit to Adjusted Gross Profit and SG&A to Adjusted SG&A. For the Thirteen Weeks Ended August 25, 2024 August 27, 2023 August 25, 2024 August 27, 2023 (in millions) Gross Profit SG&A As reported $ 356.0 $ 499.5 $ 143.9 $ 176.2 Unrealized derivative (gains) losses (2.9) (31.7) 6.0 (4.4) Foreign currency exchange losses — — (0.6) (7.4) Blue chip swap transaction gains — — 16.6 — Item impacting comparability: Inventory step-up from acquisition — 22.5 — — Integration and acquisition-related items, net — — — (4.0) Total adjustments (2.9) (9.2) 22.0 (15.8) Adjusted $ 353.1 $ 490.3 $ 165.9 $ 160.4 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 2025. 23 Table of Contents 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 I. Financial Statements” of this report.