Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Our fiscal year begins on July 1 and ends on June 30. Unless otherwise noted, references to “year” pertain to our fiscal year; for example, 2022 refers to fiscal 2022, which is the period from July 1, 2021 to June 30, 2022.
The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto in Item 8 of this Annual Report on Form 10-K. The forward-looking statements in this section and other parts of this report involve risks, uncertainties and other factors, including statements regarding our plans, objectives, goals, strategies, and financial performance. Our actual results could differ materially from the results anticipated in these forward-looking statements as a result of factors set forth under the caption “Forward-Looking Statements” and those set forth in Item 1A of this Annual Report on Form 10-K.
Our discussion of results for 2022 compared to 2021 is included herein. For discussion of results for 2021 compared to 2020, see our 2021 Annual Report on Form 10-K.
OVERVIEW
Business Overview
Lancaster Colony Corporation is a manufacturer and marketer of specialty food products for the retail and foodservice channels.
Our financial results are presented as two reportable segments: Retail and Foodservice. Costs that are directly attributable to either Retail or Foodservice are charged directly to the appropriate segment. Costs that are deemed to be indirect, excluding corporate expenses and other unusual significant transactions, are allocated to the two reportable segments using a reasonable methodology that is consistently applied. In 2021, our Chief Operating Decision Maker (“CODM”), in order to drive enhanced accountability and transparency throughout our organization, initiated a review of functional costs that had historically been part of the indirect costs allocated to our two reportable segments. This review was completed as part of our preparation for our enterprise resource planning system (“ERP”) implementation. As a result of this review, our CODM identified certain support functions that were more appropriately presented within corporate expenses to facilitate the management of the business, including assessing segment performance and allocating resources. These changes were effective in 2021, and all historical information was retroactively conformed to the current presentation. These changes had no effect on previously reported consolidated net sales, gross profit, operating income, net income or earnings per share.
Over 95% of our products are sold in the United States. Foreign operations and export sales have not been significant in the past and are not expected to be significant in the future based upon existing operations. We do not have any fixed assets located outside of the United States.
Our business has the potential to achieve future growth in sales and profitability due to attributes such as:
• leading Retail market positions in several product categories with a high-quality perception;
• recognized innovation in Retail products;
• a broad customer base in both Retail and Foodservice accounts;
• well-regarded culinary expertise among Foodservice customers;
• recognized leadership in Foodservice product development;
• experience in integrating complementary business acquisitions; and
• historically strong cash flow generation that supports growth opportunities.
Our goal is to grow both Retail and Foodservice segment sales over time by:
• introducing new products and expanding distribution;
• leveraging the strength of our Retail brands to increase current product sales;
• expanding Retail growth through strategic licensing agreements;
• continuing to rely upon the strength of our reputation in Foodservice product development and quality; and
• acquiring complementary businesses.
With respect to long-term growth, we continually evaluate the future opportunities and needs for our business specific to our plant infrastructure, IT platforms and other initiatives to support and strengthen our operations. Recent examples of resulting investments include:
• a significant capacity expansion project for our Marzetti dressing and sauce facility in Horse Cave, Kentucky that we expect to complete in the first half of fiscal 2023;
• a capacity expansion project for one of our Marzetti dressing and sauce facilities in Columbus, Ohio that was completed in January 2022;
• a significant infrastructure improvement and capacity expansion project for our frozen pasta facility in Altoona, Iowa that was completed in March 2022;
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• a significant capacity expansion project for our Sister Schubert’s frozen dinner roll facility in Horse Cave, Kentucky that was completed in January 2020; and
• the establishment of a Transformation Program Office in 2019 that serves to coordinate our various capital and integration efforts, including our ERP project and related initiatives, Project Ascent, that is currently underway.
Project Ascent commenced in late 2019 and entails the replacement of our primary customer and manufacturing transactional systems, warehousing systems, and financial systems with an integrated SAP S/4HANA system. Implementation of this system began in July 2022 and will continue throughout fiscal 2023. Customer fulfillment levels remained strong before and after the system cutover with no unplanned disruptions in receiving orders, producing products or shipping orders. We anticipate full deployment throughout our organization in the next 12-18 months.
Post implementation, Project Ascent will evolve into an on-going Center of Excellence (“COE”) that will provide oversight for all future upgrades of the S/4HANA environment, evaluation of future software needs to support the business, acquisition integration support and master data standards. Most of the on-going COE costs are expected to consist of annual software maintenance and support, consulting and professional fees and wages and benefits.
BUSINESS TRENDS
Dating back to the onset of the COVID-19 pandemic in 2020, the effects of COVID-19 on consumer behavior have impacted the relative demand for our Retail and Foodservice products. More specifically, beginning in March 2020, there has been an overall shift in consumer demand towards increased at-home food consumption and away from in-restaurant dining. While this shift in demand has been inconsistent and volatile, on balance it has positively impacted our Retail segment sales and negatively impacted our Foodservice segment sales. From an operations standpoint, the shift in demand, combined with other COVID-19-related issues, has unfavorably impacted the operating results of both our segments. These issues include higher hourly wage rates paid to our front-line employees, increased costs for personal protective equipment, higher expenditures attributed to incremental co-manufacturing volumes, increased complexity and uncertainty in production planning and forecasting, and overall lower levels of efficiency in our production and distribution network.
The inflationary cost environment we experienced during 2022 resulted in significantly higher input costs for our business. During 2022, we endured unprecedented inflationary costs for commodities, particularly soybean oil and flour, in addition to notably higher costs for packaging, freight and warehousing, and labor. This cost inflation was attributed to numerous factors such as the impacts of the COVID-19 pandemic, the war in the Ukraine, climate and weather conditions, supply chain disruptions, including some raw material and packaging shortages, a tight labor market, and government-directed fiscal stimulus actions.
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RESULTS OF CONSOLIDATED OPERATIONS
(Dollars in thousands,
except per share data)
Years Ended June 30, Change
2022 2021 2020 2022 vs. 2021 2021 vs. 2020
Net Sales $ 1,676,390 $ 1,467,067 $ 1,334,388 $ 209,323 14 % $ 132,679 10 %
Cost of Sales 1,320,671 1,080,344 976,352 240,327 22 % 103,992 11 %
Gross Profit 355,719 386,723 358,036 (31,004) (8) % 28,687 8 %
Gross Margin 21.2 % 26.4 % 26.8 %
Selling, General and Administrative Expenses 212,098 205,363 180,945 6,735 3 % 24,418 13 %
Change in Contingent Consideration (3,470) (5,687) 257 2,217 (39) % (5,944) N/M
Restructuring and Impairment Charges 35,180 1,195 886 33,985 N/M 309 35 %
Operating Income 111,911 185,852 175,948 (73,941) (40) % 9,904 6 %
Operating Margin 6.7 % 12.7 % 13.2 %
Other, Net 477 (107) 3,129 584 546 % (3,236) (103) %
Income Before Income Taxes 112,388 185,745 179,077 (73,357) (39) % 6,668 4 %
Taxes Based on Income 22,802 43,413 42,094 (20,611) (47) % 1,319 3 %
Effective Tax Rate 20.3 % 23.4 % 23.5 %
Net Income $ 89,586 $ 142,332 $ 136,983 $ (52,746) (37) % $ 5,349 4 %
Diluted Net Income Per Common Share $ 3.25 $ 5.16 $ 4.97 $ (1.91) (37) % $ 0.19 4 %
Net Sales
Consolidated net sales for the year ended June 30, 2022 increased 14% to a new record of $1,676 million from the prior-year record total of $1,467 million. This growth was driven by higher net sales for both the Retail and Foodservice segments, including the favorable impact of pricing actions. Consolidated sales volumes, measured in pounds shipped, increased 2% in 2022. In the prior year, consolidated sales volumes increased 3%.
The relative proportion of sales contributed by each of our business segments can impact a year-to-year comparison of the consolidated statements of income. The following table summarizes the sales mix over each of the last three years:
2022 2021 2020
Segment Sales Mix:
Retail 55% 57% 54%
Foodservice 45% 43% 46%
See discussion of net sales by segment following the discussion of “Earnings Per Share” below.
Gross Profit
Consolidated gross profit decreased 8% to $355.7 million in 2022 compared to $386.7 million in 2021 as we endured unprecedented inflationary costs for commodities, packaging, freight and warehousing, and labor. We also incurred incremental expenditures attributed to our increased reliance upon co-manufacturers to help satisfy demand. While our pricing actions helped to offset the impacts of inflation, the gross profit decline reflects an extremely challenging operating environment that, beyond inflation, includes the unfavorable effects of supply chain disruptions, demand volatility and uncertainty, suboptimal capacity utilization, and overall lower productivity resulting in substantially higher costs to produce our products and service our customers.
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Selling, General and Administrative Expenses
Year Ended June 30, Change
(Dollars in thousands) 2022 2021 2020 2022 vs. 2021 2021 vs. 2020
SG&A Expenses - Excluding Project Ascent $ 172,771 $ 167,480 $ 162,910 $ 5,291 3 % $ 4,570 3 %
Project Ascent Expenses 39,327 37,883 18,035 1,444 4 % 19,848 110 %
Total SG&A Expenses $ 212,098 $ 205,363 $ 180,945 $ 6,735 3 % $ 24,418 13 %
Selling, general and administrative (“SG&A”) expenses increased 3% to $212.1 million in 2022 as expenditures for Project Ascent increased $1.4 million to $39.3 million. Excluding Project Ascent, SG&A expenses were higher than the prior year reflecting investments in a supply chain optimization study and IT investments, as well as higher brokerage costs attributed to the increased sales.
Project Ascent expenses are included within Corporate Expenses. A portion of the costs that have been classified as Project Ascent expenses represent ongoing costs that will continue subsequent to the ERP implementation.
Change in Contingent Consideration
In 2022, the change in contingent consideration resulted in a benefit of $3.5 million. This benefit reflected a reduction in the fair value of the contingent consideration liability for Bantam Bagels, LLC (“Bantam”) based on our 2022 fair value measurements. The resulting fair value adjustments were due to changes in Bantam’s forecasted adjusted EBITDA for the twelve months ending December 31, 2023, as well as refinements to the estimated probabilities applied to our forecast scenarios. We recorded $2.6 million in our Foodservice segment and $0.9 million in our Retail segment. In May 2022, our Board of Directors approved a plan to exit the Bantam business. There was no liability recorded for Bantam’s contingent consideration at June 30, 2022.
In 2021, the change in contingent consideration resulted in a benefit of $5.7 million. This benefit reflected a reduction in the fair value of the contingent consideration liability for Bantam based on our 2021 fair value measurements. As the fair value adjustment resulted from the impact of a SKU rationalization by a Foodservice customer, the entire adjustment related to Bantam’s contingent consideration was reflected within the Foodservice segment.
See further discussion in Note 2 to the consolidated financial statements.
Restructuring and Impairment Charges
In 2022, we recorded restructuring and impairment charges totaling $35.2 million related to the following items:
• our decision to explore strategic alternatives and ultimately exit the Bantam business;
• the impact of a revision to the forecasted cash flows of Bantam on the intangible assets of this business;
• the impact of a revision to the forecasted branded sales of Angelic Bakehouse, Inc. (“Angelic”) on the intangible assets of this business; and
• the closure of our frozen garlic bread facility in Baldwin Park, California.
Based on our decision to explore strategic alternatives for the Bantam business, impairment testing was triggered for the related long-lived assets of the asset group. The related restructuring and impairment charges of $24.8 million included impairment charges for intangible assets, fixed assets and an operating lease right-of-use asset, as well as other closure-related costs. Due to their unusual nature, these restructuring and impairment charges were not allocated to our two reportable segments. As noted above, in May 2022, our Board of Directors approved a plan to exit the Bantam business. The operations of this business have not been classified as discontinued operations as the closure does not represent a strategic shift that would have a major effect on our operations or financial results.
In 2022, prior to our decision to explore strategic alternatives for the Bantam business, we also recorded an impairment charge of $0.9 million related to Bantam’s Retail customer relationships intangible asset, which reflected lower projected cash flows for Bantam’s Retail business. This impairment charge was reflected in our Retail segment.
In 2022, we also recorded an impairment charge of $8.8 million related to the tradename intangible asset of Angelic, which reflected the impact of lower projected sales for Angelic’s branded Retail business. This impairment charge was reflected in our Retail segment.
In 2022, we committed to a plan to close our frozen garlic bread facility in Baldwin Park, California in support of our ongoing efforts to better optimize our manufacturing network. Production at the facility ceased in January 2022, and the Mamma Bella ® brand frozen garlic bread product line was discontinued based on its small size and low profitability. The operations of this facility have not been classified as discontinued operations as the closure does not represent a strategic shift that would have a major effect on our operations or financial results. We recorded restructuring and impairment charges of
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$0.7 million, which consisted of one-time termination benefits and impairment charges for fixed assets and the operating lease right-of-use asset, and were not allocated to our two reportable segments due to their unusual nature.
We recorded impairment charges of $1.2 million in 2021 related to certain tradename and technology / know-how intangible assets for Bantam as a result of the impact of a SKU rationalization by a Foodservice customer. These impairment charges were reflected in our Foodservice segment.
Operating Income
Operating income decreased 40% to $111.9 million in 2022, including the unfavorable impacts of the $25.7 million in restructuring and impairment charges for the Bantam business and the $8.8 million impairment charge for the Angelic tradename intangible asset. Beyond those charges, operating results were negatively affected by significant inflationary costs for commodities, packaging, freight and warehousing, and labor in addition to increased co-manufacturing costs. We also experienced the unfavorable impacts of an extremely challenging operating environment characterized by supply chain disruptions, demand volatility and uncertainty, and reduced operating efficiencies. Our pricing actions helped to offset the inflationary costs. The decline in operating income also reflected the higher level of SG&A expenditures. Incremental sales attributed to advance customer orders near the end of 2022 ahead of our ERP go-live added an estimated $5 million to consolidated operating income.
See discussion of operating results by segment following the discussion of “Earnings Per Share” below.
Taxes Based on Income
Our effective tax rate was 20.3% and 23.4% in 2022 and 2021, respectively. See Note 8 to the consolidated financial statements for a reconciliation of the statutory rate to the effective rate.
We include the tax consequences related to stock-based compensation within the computation of income tax expense. We may experience increased volatility to our income tax expense and resulting net income dependent upon, among other variables, the price of our common stock and the timing and volume of share-based payment award activity such as employee exercises of stock-settled stock appreciation rights and vesting of restricted stock awards. For 2022 and 2021, the impact of net windfall tax benefits from stock-based compensation reduced our effective tax rate by 0.1% and 0.6%, respectively.
Earnings Per Share
As influenced by the factors discussed above, diluted net income per share totaled $3.25 in 2022, a decrease from the 2021 total of $5.16 per diluted share. Diluted weighted average common shares outstanding for each of the years ended June 30, 2022 and 2021 have remained relatively stable.
In 2022 and 2021, expenditures for Project Ascent reduced diluted earnings per share by $1.09 and $1.05, respectively; restructuring and impairment charges reduced diluted earnings per share by $0.98 and $0.03, respectively; and the adjustments to Bantam’s contingent consideration increased diluted earnings per share by $0.10 and $0.16, respectively.
RESULTS OF OPERATIONS - SEGMENTS
Retail Segment
Year Ended June 30, Change
(Dollars in thousands) 2022 2021 2020 2022 vs. 2021 2021 vs. 2020
Net Sales $ 915,210 $ 828,963 $ 714,127 $ 86,247 10 % $ 114,836 16 %
Operating Income $ 151,627 $ 188,403 $ 161,487 $ (36,776) (20) % $ 26,916 17 %
Operating Margin 16.6 % 22.7 % 22.6 %
In 2022, net sales for the Retail segment reached a record $915.2 million, a 10% increase from the prior-year total of $829.0 million. In addition to the benefit of pricing actions, the increase in Retail sales was driven by volume gains for Chick-fil-A ® sauces and Buffalo Wild Wings ® sauces, both of which are sold under exclusive licensing agreements. Volume gains for our New York BRAND Bakery ® frozen garlic bread and Sister Schubert’s ® frozen dinner rolls also contributed to sales growth. Retail segment sales volumes, measured in pounds shipped, increased 2% in the current year compared to an increase of 11% last year. Note that Retail segment sales volumes benefited from advance ordering by our customers near the end of the fiscal fourth quarter ahead of our ERP go-live, and the resulting incremental Retail sales were estimated to be $11 million. In addition, Retail segment sales volumes were unfavorably impacted by our decision to exit certain product lines during 2022 including some private label dips and Mamma Bella ® frozen garlic bread. Excluding the advance ordering and the product line rationalizations, Retail sales volumes increased 6%.
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In 2022, Retail segment operating income decreased 20% to $151.6 million, including the unfavorable impact of impairment charges totaling $9.7 million as referenced in the “Restructuring and Impairment Charges” section above. The decline in operating income was driven by the unfavorable impacts of increased commodity and packaging costs, significantly higher freight and warehousing costs, increased co-manufacturing costs, higher labor costs and broad-based supply chain challenges. The net impact of our pricing actions lagged the extraordinary levels of cost inflation.
Foodservice Segment
Year Ended June 30, Change
(Dollars in thousands) 2022 2021 2020 2022 vs. 2021 2021 vs. 2020
Net Sales $ 761,180 $ 638,104 $ 620,261 $ 123,076 19 % $ 17,843 3 %
Operating Income $ 82,745 $ 89,048 $ 80,475 $ (6,303) (7) % $ 8,573 11 %
Operating Margin 10.9 % 14.0 % 13.0 %
In 2022, Foodservice segment net sales increased 19% to a record $761.2 million from the 2021 total of $638.1 million driven by inflationary pricing along with the benefit of volume gains for our branded Foodservice products and select customers within our mix of national chain restaurant accounts. Note that Foodservice segment sales volumes benefited from advance ordering by our customers near the end of the fiscal fourth quarter ahead of our ERP go-live, and the resulting incremental Foodservice sales were estimated to be $14 million. Foodservice sales volumes, measured in pounds shipped, increased 2% compared to a decline of 1% last year. Excluding the benefit of advance ordering and also excluding 2021 sales attributed to a temporary supply agreement resulting from the November 2018 acquisition of Omni Baking Company LLC (“Omni”) that was terminated effective October 31, 2020, Foodservice sales volumes increased 1% in 2022.
In 2022, Foodservice segment operating income decreased 7% to $82.7 million, reflecting increased commodity and packaging costs, higher freight and warehousing expenses, higher labor costs and the unfavorable impacts of broad-based supply chain challenges as partially offset by the benefit of pricing actions.
Corporate Expenses
The 2022 corporate expenses totaled $97.0 million as compared to $91.6 million in 2021. This increase reflects increased IT investments and professional fees as well as higher expenditures for Project Ascent, which totaled $39.3 million in 2022 as compared to $37.9 million in 2021. In 2022 and 2021, we also capitalized an additional $1.6 million and $3.5 million, respectively, of ERP-related expenditures for application development stage activities.
LOOKING FORWARD
For 2023, we anticipate our Retail sales volumes will continue to benefit from the growth of our licensing program, but will also face offsets from consumer demand elasticity and rationalization initiatives for some of our low-margin products. In Foodservice, we expect sales volumes to be led by growth from select quick-service restaurant customers in our mix of national chain restaurant accounts while the external factors of a slowing economy and changes in consumer sentiment may dampen demand. Both our Retail and Foodservice sales will also continue to benefit from our pricing actions. Note that our 2023 first quarter sales will be unfavorably impacted by the advance ordering that occurred ahead of our ERP go-live near the end of 2022.
From a cost standpoint, subject to future changes in the markets for our raw materials, we are currently forecasting a notable increase in our commodity costs in the coming year versus fiscal 2022 and higher costs for other items such as packaging, labor and freight that will pose a headwind to our financial results. To help mitigate these rising costs, we recently implemented another round of price increases for dressings and sauces sold through our Retail segment while our Foodservice segment will continue to realize offsets to increased commodity and freight costs through contractual-based inflationary pricing. Our cost savings programs and other net price realization efforts will also help to offset the unfavorable impacts of inflation in the year ahead.
The implementation phase for Project Ascent, our ERP initiative, will continue throughout fiscal 2023 as we integrate additional plants and warehouses into our new ERP network.
In addition to the above commentary specific to rising commodity costs, our exposure to volatile swings in food commodity costs will continue to be managed and mitigated through a strategic forward purchasing program for certain key materials such as soybean oil and flour. For a more-detailed discussion of the effect of commodity costs, see the “Impact of Inflation” section of this MD&A below. Changes in other notable recurring costs, such as marketing, transportation, production costs and introductory costs for new products, may also impact our overall results.
We will continue to periodically reassess our allocation of capital to ensure that we maintain adequate operating flexibility while providing appropriate levels of cash returns to our shareholders.
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FINANCIAL CONDITION
Liquidity and Capital Resources
We maintain sufficient flexibility in our capital structure to ensure our capitalization is adequate to support our future internal growth prospects, acquire food businesses consistent with our strategic goals, and maintain cash returns to our shareholders through cash dividends and opportunistic share repurchases. Our balance sheet maintained fundamental financial strength during 2022 as we ended the year with $60 million in cash and equivalents, along with shareholders’ equity of $845 million and no debt.
Under our unsecured revolving credit facility (“Facility”), we may borrow up to a maximum of $150 million at any one time. We had no borrowings outstanding under the Facility at June 30, 2022. At June 30, 2022, we had $2.8 million of standby letters of credit outstanding, which reduced the amount available for borrowing under the Facility. The Facility expires in March 2025, and all outstanding amounts are then due and payable. Interest is variable based upon formulas tied to LIBOR or an alternate base rate defined in the Facility. We must also pay facility fees that are tied to our then-applicable consolidated leverage ratio. Loans may be used for general corporate purposes. Due to the nature of its terms, when we have outstanding borrowings under the Facility, they will be classified as long-term debt.
The Facility contains certain restrictive covenants, including limitations on indebtedness, asset sales and acquisitions, and financial covenants relating to interest coverage and leverage. At June 30, 2022, we were in compliance with all applicable provisions and covenants of this facility, and we exceeded the requirements of the financial covenants by substantial margins. At June 30, 2022, there were no events that would constitute a default under this facility.
We currently expect to remain in compliance with the Facility’s covenants for the foreseeable future. However, a default under the Facility could accelerate the repayment of any then outstanding indebtedness and limit our access to $75 million of additional credit available under the Facility. Such an event could require a reduction in or curtailment of cash dividends or share repurchases, reduce or delay beneficial expansion or investment plans, or otherwise impact our ability to meet our obligations when due.
We believe that cash provided by operating activities and our existing balances in cash and equivalents, in addition to that available under the Facility, should be adequate to meet our liquidity needs over the next 12 months, including the projected levels of capital expenditures and dividend payments. If we were to borrow outside of the Facility under current market terms, our average interest rate may increase and have an adverse effect on our results of operations. Based on our current plans and expectations, we believe our capital expenditures for 2023 could total between $90 and $110 million, which includes approximately $50 million in expenditures attributed to a substantial investment for a capacity expansion project at our dressing and sauce facility in Horse Cave, Kentucky that we expect to complete in the first half of fiscal 2023.
Beyond the next 12 months, we expect that cash provided by operating activities will be the primary source of liquidity. This source, combined with our existing balances in cash and equivalents and amounts available under the Facility, is expected to be sufficient to meet our overall cash requirements.
We have various contractual and other obligations that are appropriately recorded as liabilities in our consolidated financial statements, including finance lease obligations, operating lease obligations, the underfunded defined benefit pension liability, other post-employment benefit obligations, tax liabilities, noncurrent workers compensation obligations, deferred compensation and interest on deferred compensation. See Note 4 to the consolidated financial statements for further information about our lease obligations, including the maturities of minimum lease payments. It is not certain when the liabilities for the underfunded defined benefit pension liability, other post-employment benefit obligations, tax liabilities, noncurrent workers compensation obligations, deferred compensation and interest on deferred compensation will become due. See Notes 8, 11 and 12 to the consolidated financial statements for further information about these liabilities.
Certain other contractual obligations are not recognized as liabilities in our consolidated financial statements. Examples of such obligations are commitments to purchase raw materials or packaging inventory that has not yet been received as of June 30, 2022, as well as purchase orders and longer-term purchase arrangements related to the procurement of services, including IT service agreements, and property, plant and equipment. The majority of these obligations is expected to be due within one year. See further discussion below of our obligation related to the capacity expansion project at our dressing and sauce facility in Horse Cave, Kentucky.
In November 2020, T. Marzetti Company (“T. Marzetti”), a wholly-owned subsidiary of ours, entered into a Design/Build Agreement (the “Agreement”) with Gray Construction, Inc. (“Gray”) under which Gray will design, coordinate and build additional dressing and sauce manufacturing and warehousing capacity for the T. Marzetti facility in Horse Cave, Kentucky (the “Project”). The Project will result in an expansion of the current facility footprint. Subject to certain conditions in the Agreement, T. Marzetti will pay Gray no more than the guaranteed maximum price of approximately $113 million for the Project. The Agreement contains other terms and conditions that are customary for this type of project. Expected to be completed in the first half of fiscal 2023, we have a remaining commitment of approximately $30 million for the Project.
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Cash Flows
Year Ended June 30, Change
(Dollars in thousands) 2022 2021 2020 2022 vs. 2021 2021 vs. 2020
Provided By Operating Activities $ 101,813 $ 174,189 $ 170,769 $ (72,376) (42) % $ 3,420 2 %
Used In Investing Activities $ (132,240) $ (88,977) $ (83,265) $ (43,263) (49) % $ (5,712) (7) %
Used In Financing Activities $ (97,345) $ (95,430) $ (85,519) $ (1,915) (2) % $ (9,911) (12) %
Cash provided by operating activities and our existing balances in cash and equivalents remain the primary sources for funding our investing and financing activities, as well as financing our organic growth initiatives.
Cash provided by operating activities in 2022 totaled $101.8 million, a decrease of 42% as compared with the 2021 total of $174.2 million. The 2022 decrease was primarily due to the year-over-year changes in net working capital, particularly accounts payable and accrued liabilities, as well as receivables. The favorable cash flow impact of higher accounts payable was more pronounced in the prior year due to fluctuations in production levels for the comparative periods. The changes in accrued liabilities were primarily related to current-year declines in the accruals for compensation and employee benefits. The larger current-year increase in receivables reflected higher sales, including advance ordering by our customers near the end of the fiscal fourth quarter ahead of our ERP go-live. Lower net income, which was impacted by significantly higher noncash restructuring and impairment charges in 2022, also contributed to the reduced level of cash provided by operating activities.
Cash used in investing activities totaled $132.2 million in 2022 as compared to $89.0 million in 2021. The 2022 increase primarily reflected a higher level of payments for property additions in the current year. Notable capital expenditures in 2022 included spending on: a capacity expansion project at our dressing and sauce facility in Horse Cave, Kentucky that we expect to complete in the first half of fiscal 2023; a capacity expansion project for one of our Marzetti dressing and sauce facilities in Columbus, Ohio that was completed in January 2022; and infrastructure improvements and capacity expansion investments at our frozen pasta facility in Altoona, Iowa that was completed in March 2022. Capital expenditures in 2021 included spending on the capacity expansion project at our dressing and sauce facility in Horse Cave, Kentucky and the infrastructure improvements and capacity expansion investments at our frozen pasta facility in Altoona, Iowa. Payments for property additions totaled $132.0 million in 2022 compared to $87.9 million in 2021.
Financing activities used net cash totaling $97.3 million and $95.4 million in 2022 and 2021, respectively. The vast majority of the cash used in financing activities is attributed to the payment of dividends, and the 2022 increase in cash used in financing activities was primarily due to higher dividend payments. The regular dividend payout rate for 2022 was $3.15 per share, as compared to $2.95 per share in 2021. This past fiscal year marked the 59 th consecutive year of increased regular cash dividends.
The future levels of share repurchases and declared dividends are subject to the periodic review of our Board of Directors and are generally determined after an assessment is made of various factors, such as anticipated earnings levels, cash flow requirements and general business conditions.
Our ongoing business activities continue to be subject to compliance with various laws, rules and regulations as may be issued and enforced by various federal, state and local agencies. With respect to environmental matters, costs are incurred pertaining to regulatory compliance and, upon occasion, remediation. Such costs have not been, and are not anticipated to become, material.
We are contingently liable with respect to lawsuits, taxes and various other matters that routinely arise in the normal course of business. We do not have any related party transactions that materially affect our results of operations, cash flows or financial condition.
IMPACT OF INFLATION
Our business results can be influenced by significant changes in the costs of our raw materials, packaging and freight. We attempt to mitigate the impact of inflation on our raw-material costs via longer-term fixed-price contractual commitments for a portion of our most significant market-indexed commodities, most notably soybean oil and flour. We have also implemented a procurement strategy for a portion of our egg needs using grain-based pricing contracts to reduce our exposure to egg market spot prices. Specific to freight costs, our transportation network includes a mix of dedicated carriers, longer-term fixed-rate contracts and a small internal fleet that serve to reduce our exposure to spot freight rates. We also have a transportation management system in place to support our freight management processes and help us to secure more competitive freight rates. Nonetheless, we are subject to events and trends in the marketplace that will impact our costs for raw materials, packaging and freight. While we attempt to pass through sustained increases in these costs, any such price adjustments can lag the changes in the related input costs.
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Although typically less notable, we are also exposed to the unfavorable effects of general inflation beyond material and freight costs, especially in the areas of labor rates, including annual wage adjustments and benefit costs. Over time, we attempt to minimize the exposure to such cost increases through ongoing improvements and greater efficiencies throughout our manufacturing operations, including benefits gained through our lean six sigma program and strategic investments in plant equipment.
With regard to the impact of commodity and freight costs on Foodservice segment operating income, most of our supply contracts with national chain restaurant accounts incorporate pricing adjustments to account for changes in ingredient and freight costs. These supply contracts may vary by account specific to the time lapse between the actual change in ingredient and freight costs we incur and the effective date of the associated price increase or decrease. As a result, the reported operating margins of the Foodservice segment are subject to increased volatility during periods of rapidly rising or falling ingredient and/or freight costs because at least some portion of the change in ingredient and/or freight costs is reflected in the segment’s results prior to the impact of any associated change in pricing. In addition, the Foodservice segment has an inherently higher degree of margin volatility from changes in ingredient costs when compared to the Retail segment due to its overall lower margin profile and higher ratio of ingredient pounds to net sales. In Retail, there is an opportunity to offset the impact of inflationary costs through net price realization actions including list price increases, decreased trade spending and packaging size changes. Note that all these Retail cost-recovery options entail some inherent risks and uncertainties, and the implementation timeframe can lag the input cost changes. We also implement value engineering initiatives, such as the use of lower-cost packaging materials and alternative ingredients and/or recipes, to reduce Retail and Foodservice product costs to help offset inflation.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
This MD&A discusses our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these consolidated financial statements requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates and judgments, including, but not limited to, those related to accounts receivable allowances, distribution costs, asset impairments and self-insurance reserves. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Historically, the aggregate differences, if any, between our estimates and actual amounts in any year have not had a significant impact on our consolidated financial statements. While a summary of our significant accounting policies can be found in Note 1 to the consolidated financial statements, we believe the following critical accounting policies reflect those areas in which more significant judgments and estimates are used in the preparation of our consolidated financial statements.
Trade-Related Allowances
Our receivables balance is net of trade-related allowances, which consist of sales discounts, trade promotions and certain other sales incentives. We evaluate the adequacy of these allowances considering several factors including historical experience, specific trade programs and existing customer relationships. These allowances can fluctuate based on the level of sales and promotional programs as well as the timing of deductions.
Goodwill and Other Intangible Assets
Goodwill is not amortized. It is evaluated annually at April 30 by applying impairment testing procedures. Other intangible assets are amortized on a straight-line basis over their estimated useful lives to Selling, General and Administrative Expenses. We evaluate the future economic benefit of the recorded goodwill and other intangible assets when events or circumstances indicate potential recoverability concerns. Carrying amounts are adjusted appropriately when determined to have been impaired.
RECENT ACCOUNTING PRONOUNCEMENTS
Recent accounting pronouncements and their impact on our consolidated financial statements are disclosed in Note 1 to the consolidated financial statements.
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FORWARD-LOOKING STATEMENTS
We desire to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 (the “PSLRA”). This Annual Report on Form 10-K contains various “forward-looking statements” within the meaning of the PSLRA and other applicable securities laws. Such statements can be identified by the use of the forward-looking words “anticipate,” “estimate,” “project,” “believe,” “intend,” “plan,” “expect,” “hope” or similar words. These statements discuss future expectations; contain projections regarding future developments, operations or financial conditions; or state other forward-looking information. Such statements are based upon assumptions and assessments made by us in light of our experience and perception of historical trends, current conditions, expected future developments and other factors we believe to be appropriate. These forward-looking statements involve various important risks, uncertainties and other factors that could cause our actual results to differ materially from those expressed in the forward-looking statements. Actual results may differ as a result of factors over which we have no, or limited, control including, without limitation, the specific influences outlined below, many of which could be amplified by the COVID-19 pandemic. Management believes these forward-looking statements to be reasonable; however, one should not place undue reliance on such statements that are based on current expectations. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update such forward-looking statements, except as required by law.
Items which could impact these forward-looking statements include, but are not limited to, those risk factors identified in Item 1A and:
• inflationary pressures resulting in higher input costs;
• efficiencies in plant operations and our overall supply chain network;
• adverse changes in freight, energy or other costs of producing, distributing or transporting our products;
• significant shifts in consumer demand and disruptions to our employees, communities, customers, supply chains, production planning, operations, and production processes resulting from the impacts of COVID-19 and other epidemics, pandemics or similar widespread public health concerns and disease outbreaks;
• the reaction of customers or consumers to pricing actions we take to offset inflationary costs;
• fluctuations in the cost and availability of ingredients and packaging;
• dependence on contract manufacturers, distributors and freight transporters, including their operational capacity and financial strength in continuing to support our business;
• the impact of customer store brands on our branded retail volumes;
• capacity constraints that may affect our ability to meet demand or may increase our costs;
• adequate supply of labor for our manufacturing facilities;
• cyber-security incidents, information technology disruptions, and data breaches;
• complexities related to the implementation of our new enterprise resource planning system;
• geopolitical events, such as Russia’s recent invasion of Ukraine, that could create unforeseen business disruptions and impact the cost or availability of raw materials and energy;
• the potential for loss of larger programs, including licensing agreements, or key customer relationships;
• changes in demand for our products, which may result from loss of brand reputation or customer goodwill;
• price and product competition;
• the possible occurrence of product recalls or other defective or mislabeled product costs;
• the success and cost of new product development efforts;
• the lack of market acceptance of new products;
• the extent to which recent and future business acquisitions are completed and acceptably integrated;
• the ability to successfully grow recently acquired businesses;
• dependence on key personnel and changes in key personnel;
• the effect of consolidation of customers within key market channels;
• maintenance of competitive position with respect to other manufacturers;
• stability of labor relations;
• changes in estimates in critical accounting judgments;
• the impact of any regulatory matters affecting our food business, including any required labeling changes and their impact on consumer demand;
• the outcome of any litigation or arbitration;
• the impact of fluctuations in our pension plan asset values on funding levels, contributions required and benefit costs; and
• certain other risk factors, including those discussed in other filings we have submitted to the Securities and Exchange Commission.
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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.