Lamb Weston Holdings, Inc. - Annual Report: 2018 (Form 10-K)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended May 27, 2018

OR

For the transition period from                 to 

Commission File Number: 1-37830

LAMB WESTON HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

(208) 938-1047

(Registrant’s telephone number, including area code)

Securities registered pursuant to section 12(b) of the Act:

 

Securities registered pursuant to section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒    No ☐

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐    No ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes ☒    No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes ☒    No ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10‑K. ☒

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes ☐    No ☒

The aggregate market value of the voting common stock of Lamb Weston Holdings, Inc. held by non-affiliates on November 26, 2017 (the last business day of the Registrant's most recently completed second fiscal quarter) was approximately $7.96 billion based upon the closing sale price on the New York Stock Exchange on such date. As of July 16, 2018, the Registrant had 146,332,332 shares of common stock, par value $1.00 per share, outstanding.

Documents Incorporated by Reference

Portions of the Registrant's definitive proxy statement to be filed with the Securities and Exchange Commission in connection with its 2018 Annual Meeting of Stockholders are incorporated by reference into Part III of this report.

 

 

 

Table of Contents

 

All reports we file with the U.S. Securities and Exchange Commission (“SEC”) are available free of charge via the Electronic Data Gathering Analysis and Retrieval (“EDGAR”) System on the SEC’s website at www.sec.gov. We also provide copies of our SEC filings at no charge upon request and make electronic copies of our reports available through our website at www.lambweston.com as soon as reasonably practicable after filing such material with the SEC.

 

Forward-Looking Statements

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the federal securities laws. Words such as “will,” “may,” “expect,” “would,” “could,” “intend,” “plan,” “believe,” “estimate,” “deliver,” “grow,” “invest,” “support,” “drive,” “outlook,” and variations of such words and similar expressions are intended to identify forward-looking statements. Examples of forward-looking statements include, but are not limited to, statements regarding our plans, execution, capital investments, dividends, taxes, and business outlook and prospects. These forward-looking statements are based on management’s current expectations and are subject to uncertainties and changes in circumstances. Readers of this report should understand that these statements are not guarantees of performance or results. Many factors could affect our actual financial results and cause them to vary materially from the expectations contained in the forward-looking statements, including those set forth in this report. These risks and uncertainties include, among other things: 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; 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; disruption of our access to export mechanisms; risks associated with possible acquisitions, including our ability to complete acquisitions or integrate acquired businesses; our debt levels; the availability and prices of raw materials; changes in our relationships with our growers or significant customers; the success of our joint ventures; actions of governments and regulatory factors affecting our businesses or joint ventures; the ultimate outcome of litigation or any product recalls; levels of pension, labor and people-related expenses; our ability to pay regular quarterly cash dividends and the amounts and timing of any future dividends; and other risks described in our reports filed from time to time with the SEC, including those described under the heading “Item 1A. Risk Factors” in this report. We caution readers not to place undue reliance on any forward-looking statements included in this report, which speak only as of the date of this report. We undertake no responsibility for updating these statements, except as required by law. 

 

PART I

ITEM 1. BUSINESS

 

Lamb Weston Holdings, Inc. (“we,” “us,” “our,” “the Company,” or “Lamb Weston”), along with its joint venture partners, is a leading global producer, distributor, and marketer of value-added frozen potato products and is headquartered in Eagle, Idaho. We, along with our joint venture partners, are the number one supplier of value-added frozen potato products in North America. We are also a leading supplier of value-added frozen potato products internationally, with a strong and growing presence in high-growth emerging markets. We, along with our joint venture partners, 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.

 

We were organized as a Delaware corporation in July 2016, as a wholly owned subsidiary of Conagra Brands, Inc. (formerly, ConAgra Foods, Inc., “Conagra”). On November 9, 2016, we separated from Conagra and became an independent publicly traded company through the pro rata distribution by Conagra of 100% of our outstanding common stock to Conagra stockholders (“Separation” or “spinoff”). Each Conagra stockholder of record on November 1, 2016 (“record date”) received one share of our common stock for every three shares of Conagra common stock held on the record date. As a result of the Separation, approximately 146 million shares of our common stock were distributed on November 9, 2016, to Conagra stockholders. On November 10, 2016, our common stock began trading under the ticker symbol “LW” on the New York Stock Exchange (“NYSE”).

 

In connection with the Separation, we entered into a separation and distribution agreement and several other agreements with Conagra, including a transition services agreement, tax matters agreement, employee matters agreement, and trademark license agreement. These agreements govern the relationship between us and Conagra following the Separation and provide for the allocation of various assets, liabilities, rights and obligations of the parties. These agreements also include arrangements for transition services to be provided by Conagra to Lamb Weston. For a discussion of these agreements, see the section entitled “Relationship with ConAgra After the Spinoff” in our registration statement on Form 10, as amended, as filed with the SEC on October 17, 2016 (“Form 10”), and Note 3, Related Party Transactions,

of the Notes to Combined and Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” in this Form 10-K. In April 2018, we concluded our transition services agreement with Conagra.

 

In connection with the Separation, Conagra transferred substantially all of the assets and liabilities and operations of the Lamb Weston business to us. Combined financial statements for Lamb Weston for periods prior to the Separation were prepared on a stand-alone basis and were derived from Conagra’s consolidated financial statements and accounting records. The combined financial statements for Lamb Weston contained in this report for periods prior to the Separation reflect our financial position, results of operations, comprehensive income, and cash flows as our business was operated as part of Conagra prior to the Separation and include allocations for a portion of Conagra’s shared corporate general and administrative expenses. Following the Separation, our consolidated financial statements include the accounts of Lamb Weston Holdings, Inc., its wholly owned subsidiaries, and Lamb Weston BSW, LLC, which we own a 49.99% interest in, but we consolidate because we are the primary beneficiary. The combined financial position, results of operations, and cash flows as of dates and for periods prior to the Separation may not be indicative of what our financial position, results of operations and cash flows would have been as a separate stand-alone public company during the periods presented, nor are they indicative of what our financial position, results of operations and cash flows may be in the future. Information related to the Separation and its effect on our financial statements are discussed throughout this Form 10‑K.

 

Segments

 

We have four reportable segments: Global, Foodservice, Retail, and Other. For segment financial information see Note 13, Segments, of the Notes to Combined and Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” of this Form 10‑K.

 

Global

 

Our Global segment includes branded and private label frozen potato products sold in North America and international markets. This segment includes the top 100 North American based restaurant chains and international customers comprised of global and regional restaurant chains, foodservice distributors, and retailers. We have included non-U.S. and non-Canadian retail and foodservice customers in the Global segment due to efficiencies associated with coordinating sales to all customer types within specific markets, as well as due to these customers’ smaller scale and dependence on local economic conditions. The Global segment’s product portfolio includes frozen potatoes, sweet potatoes, and appetizers sold under the Lamb Weston® brand, as well as many customer labels.

 

Foodservice

 

Our Foodservice segment includes branded and private label frozen potato products sold throughout the United States and Canada. The Foodservice segment’s primary products are frozen potatoes, sweet potatoes, commercial ingredients, and appetizers sold under the Lamb Weston® brand, as well as many customer labels. Our products are sold primarily to commercial distributors, restaurant chains outside the top 100 North American based restaurant chains, and non-commercial channels.

 

Retail

 

Our Retail segment includes consumer facing retail branded and private label frozen potato products sold primarily to grocery, mass merchants, club, and specialty retailers. The Retail segment’s primary products are frozen potatoes and sweet potato items sold under our owned or licensed brands, including Grown in Idaho® and Alexia®, other licensed equities comprised of brand names of major North American restaurant chains, and the retailers’ own brands.

 

Other

 

The Other reporting segment primarily includes our vegetable and dairy businesses.

 

Joint Venture Relationships

 

We conduct business through two unconsolidated joint ventures and include our share of the earnings of these affiliates as equity method investment earnings in our combined and consolidated financial statements based on our economic ownership interest in each of these joint ventures. These two joint ventures produce and market value-added frozen potato products for our customers:

 

 

 

In addition, we hold a 49.99% interest in Lamb Weston BSW, LLC (“Lamb Weston BSW”), a potato processing venture with Ochoa Ag Unlimited Foods, Inc. (“Ochoa”). We provide all sales and marketing services to Lamb Weston BSW. Lamb Weston BSW is a variable interest entity, and we have determined that we are the primary beneficiary of the entity. We consolidate the financial statements of Lamb Weston BSW. In June 2018, we provided notice to Ochoa of our exercise of a call option to purchase Ochoa’s interest in Lamb Weston BSW. We expect to pay approximately $65 million and will consummate the transaction as soon as practicable. For more information, see Note 6, Investments in Joint Ventures, of the Notes to Combined and Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” of this Form 10-K.

 

Sales, Distribution and Customers

 

We benefit from strong relationships with a diverse set of customers. We sell our products through a combined network of internal sales personnel and independent brokers, agents, and distributors to chain restaurants, wholesale, grocery, mass merchants, club, specialty retailers, and foodservice distributors and institutions, including businesses, educational institutions, independent restaurants, regional chain restaurants, and convenience stores. We have long-tenured relationships with leading quick service and fast casual restaurants, global foodservice distributors, large grocery retailers, and mass merchants.

 

Our largest customer, McDonald’s Corporation, accounted for approximately 11% of our consolidated “net sales” in each of fiscal 2018, 2017 and 2016. No other customer accounted for more than 10% of our fiscal 2018, 2017, or 2016 consolidated net sales. Accounts receivable from another customer accounted for 12% of our consolidated accounts receivable at May 27, 2018. Accounts receivable from an additional customer accounted for 10% of our consolidated accounts receivable at May 28, 2017. 

 

International Operations

 

At May 27, 2018, we had operations in twelve countries, with manufacturing and processing facilities in three countries. Foreign net sales, including sales by domestic segments to customers located outside of the United States and Canada, were approximately $665.8 million, $663.5 million, and $615.9 million in fiscal 2018, 2017, and 2016, respectively. Our long-lived assets located outside of the United States are not significant. See Note 13, Segments, of the Notes to Combined and Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” of this Form 10-K for additional information on our U.S. and non-U.S. operations. Also see “Item 2. Properties,” for more information on our manufacturing and other facilities. For a discussion of risks related to our operations outside the United States, see “Item 1A. Risk Factors” of this Form 10-K.

 

Research and Development

 

We leverage our research and development resources for both growth and efficiency initiatives. We seek to drive growth through innovation by creating new products, enhancing the quality of existing products, and participating in joint menu planning exercises with our customers. We also emphasize sustainability in our research and development activities and continue to drive processing innovations aimed at reducing waste and water usage. Research and development expense was $13.5 million, $10.6 million, and $6.7 million in fiscal 2018, 2017, and 2016, respectively.

 

Raw Materials and Packaging

 

Our primary raw materials are potatoes, edible oils, energy, and packaging. We source a significant amount of our raw potatoes under both strategic, long-term grower relationships and shorter-term annual contracts. In the United States, most of the potato crop used in value-added products is grown in Idaho, Oregon, and Washington. For Lamb-Weston/Meijer, European growing regions for the necessary potatoes are concentrated in the Netherlands, Belgium, Germany, France, the United Kingdom, and China. We believe that the grower networks to which we have access provide a sufficient source of raw potato inputs year-to-year. We source edible oils through strategic relationships with key suppliers, and we source energy and packaging materials through multiple suppliers under a variety of agreement types.

 

The prices paid for these raw materials, as well as other raw materials used in making our products, generally reflect factors such as weather, commodity market fluctuations, currency fluctuations, tariffs, and the effects of governmental agricultural programs. Although the prices of raw materials can be expected to fluctuate as a result of these factors, we believe such raw materials to be in adequate supply.

 

From time to time, we have faced increased costs for our significant raw materials, packaging and energy inputs. We seek to mitigate higher input costs through long-term relationships, contract strategies, and hedging activities where an active market for an input exists, as well as through our productivity and pricing initiatives.

 

Manufacturing

 

We own and operate 15 manufacturing facilities for our products. See "Item 2. Properties" for more information about our manufacturing facilities.

 

In addition to our own manufacturing facilities, we source a portion of our products under “co-packing” agreements, a common industry practice in which manufacturing is outsourced to other companies. We regularly evaluate our co-packing arrangements to ensure the most cost-effective manufacturing of our products and to utilize company-owned manufacturing facilities most effectively.

 

Backlog

 

We manufacture primarily to fill customer orders from finished goods inventories. While at any given time there may be some backlog of orders due to the seasonal nature of our manufacturing activities and associated inventory, such backlog is not material in respect to annual net sales, and the changes of backlog orders from time to time are not significant.

 

Competition

 

The value-added frozen potato products industry in both North America and international markets is highly competitive. Competitors include large national and international frozen potato product companies, as well as local and regional companies. Significant competitors include McCain Foods, J.R. Simplot Company, Cavendish Farms, and The Kraft Heinz Company. Some of our competitors are larger and have substantially more financial, sales and marketing, and other resources. We compete with producers of similar products on the basis of, among other things, customer service,

value, product innovation, product quality, food safety, brand recognition and loyalty, price, and the ability to identify and satisfy customer preferences. The markets in which we operate are expected to remain highly competitive for the foreseeable future. See also “Item 1A. Risk Factors – Increased competition may result in reduced sales or profits” of this Form 10-K.

 

Trademarks, Licenses and Patents

 

Our trademarks are material to our business and are protected by registration or other means in the United States and most other geographic markets where the related food items are sold. Depending on the country, trademarks generally remain valid for as long as they are in use and their registration status is maintained. Trademark registrations generally are for renewable, fixed terms. Our significant trademarks include: Lamb Weston, Lamb’s Supreme, Lamb Weston Seeing Possibilities in Potatoes (and design), Lamb’s Seasoned, LW Private Reserve, Stealth Fries, and Sweet Things. We also sell certain products under brands, such as Grown in Idaho and Alexia, which we license from third parties.

 

We own numerous patents worldwide. We consider our portfolio of patents, patent applications, patent licenses under patents owned by third parties, proprietary trade secrets, technology, know-how processes, and related intellectual property rights to be material to our operations. Patents, issued or applied for, cover inventions, including packaging, manufacturing processes, equipment, formulations, and designs. Our issued patents extend for varying periods according to the date of the patent application filing or grant and the legal term of patents in the various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage as determined by the patent office or courts in the country, and the availability of legal remedies in the country. While we consider our patent portfolio to be material to our business, the loss of one patent or a group of related patents would not have a material adverse effect on our business.

 

Seasonality

 

Our product contribution margin percentage, inventory levels, net sales and cash flows are affected by seasonality. In general, our product contribution margin percentage tends to be highest in our fiscal third quarter, reflecting the benefit of freshly-harvested potatoes. We typically harvest potatoes in the Pacific Northwest of the United States in July through October, which is primarily in our fiscal second quarter. Freshly-harvested potatoes process more efficiently in our production lines and are not subject to storage or secondary transport costs. We typically hold about 60 days of finished goods inventory on a first-in-first-out basis, so the relatively favorable costs primarily incurred from our fiscal second quarter harvest flow through our income statement in our fiscal third quarter. Inventory levels also tend to be higher in our fiscal third quarter, requiring more working capital at that time. In general, net sales and cash flows tend to be higher in our fiscal fourth quarter, reflecting customer and consumer buying patterns.

 

Employees

 

As of June 30, 2018, we had approximately 7,200 employees, excluding our joint ventures. Approximately 700 of these employees work outside of the United States. Approximately 26% of our hourly employees are parties to collective bargaining agreements on terms that we believe are typical for the industry in which we operate. Most of the union workers at our facilities are represented under contracts that expire at various times throughout the next several years. Approximately 44% expire in fiscal 2019. As these agreements expire, we believe they will be renegotiated on terms satisfactory to us. 

 

Executive Officers

 

The following are our executive officers as of July 16, 2018:

 

 

Thomas P. Werner has served as our President and Chief Executive Officer and a member of our Board of Directors since November 2016. He previously served as President, Commercial Foods, for Conagra, a food company, since May 2015. In that role, he led the company’s Lamb Weston and Foodservice businesses, as well as its previously divested Spicetec Flavors & Seasonings and J.M. Swank operations. Mr. Werner also served as interim President of Conagra’s Private Brands from June 2015 through its divestiture in February 2016. Before his appointment as President, Commercial Foods, Mr. Werner served as Senior Vice President of Finance for Conagra’s Private Brands and Commercial Foods operating segments from June 2013 to April 2015, and Senior Vice President of Finance for Lamb Weston from May 2011 until June 2013.

 

Robert M. McNutt has served as our Senior Vice President and Chief Financial Officer since January 2017. Prior to joining Lamb Weston, Mr. McNutt served as Chief Financial Officer of Expera Specialty Solutions, LLC, a specialty paper company, from September 2013 to December 2016. Mr. McNutt served as Senior Vice President and Chief Financial Officer for Greif, Inc., an industrial packaging company, from January 2011 to July 2013, and as Senior Vice President and Chief Financial Officer for Boise Inc., a packaging and paper products manufacturer, from February 2008 to January 2011.

 

Micheline C. Carter has served as our Senior Vice President and Chief Human Resources Officer since November 2016. Ms. Carter joined Lamb Weston in September 2016. From July 2012 until September 2016, she served in a variety of roles with The Kraft Heinz Company, a food and beverage company, including as Head of U.S. People and Performance and Global Corporate Functions from November 2015 to September 2016, Vice President of Human Resources, Global Corporate Functions from August 2015 until October 2015, Vice President of Human Resources, Cheese & Dairy from January 2015 until July 2015, and Senior Director Human Resources & Global Exports from July 2012 until January 2015. Before joining The Kraft Heinz Company, Ms. Carter served from February 2011 until July 2012 as Senior Director Human Resources, Solar Energy & Solar Materials with MEMC Electronic Materials, Inc. (now known as SunEdison, Inc.), a supplier of silicon wafers to semiconductor and photovoltaic cell companies. Before that, Ms. Carter served in a variety of roles with J. C. Penney Company, Inc., an apparel and home furnishings retailer, Yum! Brands, Inc., an operator of fast food companies, and Texas Instruments Incorporated, a semiconductor design and manufacturing company.

 

Richard A. Martin has served as our Senior Vice President and Chief Supply Chain Officer since September 2016. Mr. Martin joined Conagra as a Manufacturing Manager in 1994, and from 1997 to 2003, he served as Plant Manager of several of our facilities. Mr. Martin also served as Director of Operations from 2003 to 2005, Vice President, Manufacturing from 2005 to 2011, and Vice President, Global Operations from 2011 until 2016. Before joining Lamb Weston, Mr. Martin spent 15 years at General Foods Corporation and Kraft Foods Inc., food and beverage companies, in a variety of engineering and manufacturing positions.

 

Sharon L. Miller has served as our Senior Vice President and General Manager, Global Business Unit since September 2016. Before that, she served as Conagra’s Vice President and General Manager, Lamb Weston Global Business Unit since 2015. Since joining Conagra in 1999, Ms. Miller has held various leadership positions, including Vice President of Sales for Lamb Weston's European joint venture, Lamb-Weston/Meijer v.o.f. Prior to that, Ms. Miller was a key sales and business leader within Lamb Weston in both the United States and Canada. She also has held various sales positions with North American food manufacturers and foodservice distributors.

 

Michael J. Smith has served as our Senior Vice President and General Manager, Foodservice and Retail Business Units and Marketing and Innovation since April 2018. Prior to that, he served as Senior Vice President, Growth and Strategy beginning in September 2016. Mr. Smith also served as Vice President and General Manager of Lamb Weston Retail from May 2011 to September 2016, Vice President and General Manager of Conagra’s Private Brands from March 2014 to February 2016, and Vice President of Global Marketing of Lamb Weston from July 2012 to March 2014. Prior to joining Conagra in 2007, Mr. Smith held various brand management roles at Dean Foods Company, a food and beverage company, and its WhiteWave division from May 2003 until December 2007.

 

Eryk J. Spytek has served as our Senior Vice President, General Counsel and Corporate Secretary since October 2016. From June 2015 until October 2016, Mr. Spytek was Of Counsel at Winston & Strawn LLP, a law firm. Before returning to Winston & Strawn LLP, he served from December 2009 until April 2015 in a variety of roles with Mead Johnson Nutrition Company, a manufacturer of infant formula, including as Vice President, Deputy General Counsel and Assistant Secretary from April 2013 to April 2015 and as Vice President, Associate General Counsel and Assistant Secretary from December 2009 to April 2013. Before that, Mr. Spytek served as Senior Vice President, General Counsel and Secretary at SIRVA, Inc., a moving and relocation services provider, from February 2006 to February 2009. Before joining SIRVA, Inc., Mr. Spytek was a partner at Winston & Strawn LLP.

 

Ethics and Governance

 

We have adopted a code of conduct that applies to all of our employees, as well as a code of ethics for senior corporate financial officers that applies to our Chief Executive Officer, Chief Financial Officer, and Controller. These codes are available on our website at www.lambweston.com through the “Investors—Corporate Governance” link. We will disclose any waiver we grant to our Chief Executive Officer, Chief Financial Officer, or Controller under our codes, or certain amendments to the codes, on our website at www.lambweston.com.

 

In addition, we adopted Corporate Governance Principles and charters for the Audit and Finance Committee, Nominating and Corporate Governance Committee, and Compensation Committee. All of these materials are available on our website at www.lambweston.com and will be provided free of charge to any stockholder requesting a copy by writing to: Corporate Secretary, Lamb Weston Holdings, Inc., 599 S. Rivershore Lane, Eagle, Idaho 83616.

 

The information on our website is not, and shall not be deemed to be, a part of this Form 10-K or incorporated into any other filings we make with the SEC.

 

Food Safety and Labeling

 

We are subject to extensive regulation, including, among other things, the Food, Drug and Cosmetic Act, as amended by the Food Safety Modernization Act, the Public Health Security and Bioterrorism Preparedness and Response Act of 2002, and the rules and regulations promulgated thereunder by the U.S. Food and Drug Administration (“FDA”). This comprehensive and evolving regulatory program governs, among other things, the manufacturing, composition and ingredients, labeling, packaging, and safety of food, including compliance with current Good Manufacturing Practices. In addition, the Nutrition Label Reform Act of 2016 prescribes the format and content in which specific nutrition information is required to appear on the labels of food products. We are also subject to regulation by certain other governmental agencies, including the U.S. Department of Agriculture.

 

Our operations and products are also subject to state and local regulation, including the registration and licensing of plants, enforcement by state health agencies of various state standards, and the registration and inspection of facilities. Compliance with federal, state, and local regulation is costly and time-consuming. Enforcement actions for violations of federal, state, and local regulations may include seizure and condemnation of products, cease and desist orders, injunctions, or monetary penalties. We believe that our practices are sufficient to maintain compliance with applicable government regulations.

 

Environmental, Health and Safety Regulations

 

We are subject to a number of federal, state, and local laws and other regulations relating to the protection of the environment and the safety and health of personnel and the public. These requirements apply to a broad range of our activities, including: the discharge of pollutants into the air and water; the identification, generation, storage, handling, transportation, disposal, recordkeeping, labeling, and reporting of, and emergency response in connection with, hazardous materials; noise emissions from our facilities; and safety and health standards, practices, and procedures that apply to the workplace and the operation of our facilities.

 

In order to comply with these requirements, we may need to spend substantial amounts of money and other resources from time to time to (i) construct or acquire new equipment, (ii) acquire or amend permits to authorize facility operations, (iii) modify, upgrade, or replace existing and proposed equipment, and (iv) clean up or decommission our facilities or other locations in accordance with regulatory requirements. Our capital and operating budgets include costs and expenses associated with complying with these laws and other requirements.

 

Available Information

 

We make available, free of charge on our website at www.lambweston.com, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after we electronically file them with, or furnish them to, the SEC. We use our website, through the “Investors” link, as a channel for routine distribution of important information, including news releases, analyst presentations, and financial information. The information on our website is not, and shall not be deemed to be, a part of this Form 10-K or incorporated into any other filings we make with the SEC unless expressly noted.

 

ITEM 1A. RISK FACTORS

 

Our business is subject to various risks and uncertainties. Any of the risks and uncertainties described below could materially and adversely affect our business, financial condition, and results of operations and should be considered in evaluating us. While we believe we have identified and discussed below the material risks affecting our business, there may be additional risks and uncertainties that we do not presently know or that we do not currently believe to be material that may adversely affect our business, financial condition, or results of operations in the future.

 

Increased competition may result in reduced sales or profits.

 

Our business, value-added frozen potato products, is highly competitive. Our principal competitors have substantial financial, sales and marketing, and other resources. A strong competitive response from one or more of our competitors to our marketplace efforts could result in us reducing pricing, increasing promotional activity or losing market share. Competitive pressures also may restrict our ability to increase prices, including in response to commodity and other input cost increases or additional improvements in product quality. Our profits could decrease if a reduction in prices or increased costs are not counterbalanced with increased sales volume.

 

Increased industry capacity may result in reduced sales or profits.

 

In recent years, market demand for value-added frozen potato products has exceeded industry capacity to produce these products. As additional industry capacity comes online, or market demand otherwise decreases, we may face competitive pressures that would restrict our ability to increase or maintain prices. Our profits would decrease as a result of a reduction in prices or sales volume.

 

Our business, financial condition, and results of operations could be adversely affected by the political and economic conditions of the countries in which we conduct business and other factors related to our international operations, including foreign currency risks and trade barriers.

 

We conduct a substantial and growing amount of business with customers located outside the United States and Canada, including through our joint ventures. During each of fiscal 2018, 2017, and 2016, net sales outside the United States and Canada, primarily in Japan, China, Korea, Mexico, and Taiwan, accounted for approximately 20% of our net sales. These amounts do not include any impact of unconsolidated net sales associated with our joint ventures, which are also subject to risks associated with international operations.

 

Many factors relating to our international sales and operations, many of which factors are outside of our control, could have a material adverse impact on our business, financial condition, and results of operations, including:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Any of these factors could have an adverse effect on our business, financial condition, and results of operations.

 

Disruption of our access to export mechanisms could have an adverse impact on our business, financial condition, and results of operations.

 

To serve our customers globally, we rely in part on our international joint venture partnerships, but also on exports from the United States. During fiscal 2018, export sales accounted for 19% of our total net sales. Circumstances beyond our control, such as a labor dispute at a port, could prevent us from exporting our products in sufficient quantities to meet customer opportunities. We have access to production overseas through our facility in China and joint venture in Europe, but we may be unsuccessful in mitigating any future disruption to export mechanisms. If this occurs, we may be unable to adequately supply all of our customer opportunities, which could adversely affect our business, financial condition, and results of operations.

 

Our substantial debt may limit cash flow available to invest in the ongoing needs of our business and could prevent us from fulfilling our debt obligations.

 

We incurred substantial indebtedness in connection with the Separation. As of May 27, 2018, we had $2,375.4 million of long-term debt, including current portion, recorded on our Consolidated Balance Sheet. We have the ability under our existing revolving credit facility to incur additional substantial debt. Our level of debt could have important consequences. For example, it could:

 

 

 

 

 

 

The agreements governing our debt contain various covenants that impose restrictions on us that may affect our ability to operate our business.

 

The credit agreement governing our term loan and revolving credit facility and the indentures governing our senior notes contain covenants that, among other things, limit our ability to:

 

 

 

 

 

 

 

 

These restrictions on our ability to operate our business could harm our business by, among other things, limiting our ability to take advantage of financing, merger and acquisition, and other corporate opportunities. Various risks, uncertainties, and events beyond our control could affect our ability to comply with these covenants. Failure to comply with any of the covenants in our existing or future financing agreements could result in a default under those agreements and under other agreements containing cross-default provisions. A default would permit lenders to accelerate the maturity of the debt under these agreements and to foreclose upon any collateral securing the debt. Under these circumstances, we might not have sufficient funds or other resources to satisfy all of our obligations. In addition, the limitations imposed by financing agreements on our ability to incur additional debt and to take other actions might significantly impair our ability to obtain other financing.

 

Additionally, any failure to meet required payments on our debt, or failure to comply with any covenants in the instruments governing our debt, could result in a downgrade to our credit ratings. A downgrade in our credit ratings could limit our access to capital and increase our borrowing costs.

 

Our business relies on a potato crop that has a concentrated growing region.

 

Ideal growing conditions for the potatoes necessary for our value-added products (e.g., french fries) are concentrated in a few geographic regions globally. In the United States, most of the potato crop used in value-added products is grown in Idaho, Oregon, and Washington. European growing regions for the necessary potatoes are concentrated in Belgium, France, Germany, the Netherlands, and the United Kingdom. Recent agronomic developments have opened new growing regions, but the capital-intensive nature of our industry’s production processes has kept production highly concentrated in the historical growing regions. Unfavorable crop conditions in any one region could lead to significant demand on the other regions for production. Our inability to mitigate any such conditions by leveraging our production capabilities in other regions could negatively impact our ability to meet customer opportunities and could decrease our profitability.

 

Our business is affected by potato crop performance.

 

Our primary input is potatoes and every year, we must procure potatoes that meet the quality standards for processing into value-added products. Environmental and climate conditions, such as soil quality, moisture, and

temperature, affect the quality of the potato crop on a year-to-year basis. As a result, we source potatoes from specific regions of the United States and specific countries abroad, including Belgium, France, Germany, the Netherlands, the United Kingdom, Canada, and China, where we believe the optimal potato growing conditions exist. However, severe weather conditions during the planting and growing season in these regions can significantly affect potato crop performance. Potatoes are also susceptible to pest diseases and insects that can cause crop failure, decreased yields, and negatively affect the physical appearance of the potatoes. We have deep experience in agronomy and actively work to monitor the potato crop. However, if a weather or pest-related event occurs in a particular crop year, and our agronomic programs are insufficient to mitigate the impacts thereof, we may have insufficient potatoes to meet our customer opportunities, and our competitiveness and profitability could decrease. Alternatively, overly favorable growing conditions can lead to high per acre yields and over-supply. An increased supply of potatoes could lead to overproduction of finished goods or destruction of unused potatoes at a loss.

 

Increases in commodity costs may have a negative impact on profits.

 

A significant portion of our cost of goods comes from commodities such as oil and energy. Commodities are subject to price volatility caused by commodity market fluctuations, supply and demand, currency fluctuations, external conditions such as weather and changes in governmental agricultural and energy policies and regulations. Commodity price increases will increase our operating costs. We may not be able to increase our product prices and achieve cost savings that fully offset these increased costs; and increasing prices may result in reduced sales volume and decreased profitability. There is currently no active derivatives market for potatoes in the United States. Although we have experience in hedging against commodity price increases, these practices and experience reduce, but do not eliminate, the risk of negative profit impacts from commodity price increases. As a result, the risk management procedures that we use may not always work as we intend.

 

If we do not achieve the appropriate cost structure in the highly competitive value-added frozen potato product category, our profitability could decrease.

 

Our future success and earnings growth depend in part on our ability to maintain the appropriate cost structure and operate efficiently in the highly competitive value-added frozen potato product category. We continue to implement profit-enhancing initiatives that improve the efficiency of our supply chain and general and administrative functions. These initiatives are focused on cost-saving opportunities in procurement, manufacturing, logistics, and customer service, as well as general and administrative overhead levels. However, gaining additional efficiencies may become more difficult over time. Our failure to reduce costs through productivity gains or the elimination of redundant costs could adversely affect our profitability and weaken our competitive position.

 

Changes in our relationships with our growers could adversely affect us.

 

We expend considerable resources to develop and maintain relationships with many potato growers. In some instances, we have entered into long-term agreements with growers; however, a portion of our potato needs are typically sourced on an annual basis. To the extent we are unable to maintain positive relationships with our long-term growers, contracted growers deliver less supply than we expect, or we are unable to secure sufficient potatoes from uncontracted growers in a given year, we may not have sufficient potato supply to satisfy our business opportunities. To obtain sufficient potato supply, we may be required to purchase potatoes at prices substantially higher than expected, or forgo sales to some market segments, which would reduce our profitability. If we forgo sales to such market segments, we may lose customers and may not be able to replace them later.

 

Changes in our relationships with significant customers could adversely affect us.

 

We maintain a diverse customer base across our four reporting segments. Customers include global, national and regional quick serve and fast casual restaurants as well as small, independently operated restaurants, multinational, broadline foodservice distributors, as well as regional foodservice distributors, and major food retailers. Some of these

customers independently represent a meaningful portion of our sales. While we contract annually or biannually with many of our foodservice customers, loss of a significant customer could materially impact the business. In addition, shelf space at food retailers is not guaranteed. During each of fiscal 2018, 2017, and 2016, our largest customer, McDonald’s Corporation and its affiliates, accounted for approximately 11% of our net sales. There can be no assurance that our customers will continue to purchase our products in the same quantities or on the same terms as in the past. The loss of a significant customer or a material reduction in sales to a significant customer could materially and adversely affect our business, financial condition, and results of operations.

 

The sophistication and buying power of some of our customers could have a negative impact on profits.

 

Some of our customers are large and sophisticated, with buying power and negotiating strength. These customers may be more capable of resisting price increases and more likely to demand lower pricing, increased promotional programs, or specialty tailored products. In addition, some of these customers (e.g., larger distributors and supermarkets) have the scale to develop supply chains that permit them to operate with reduced inventories or to develop and market their own brands. We continue to implement initiatives to counteract these pressures, including efficiency programs and investments in innovation and quality. However, if we are unable to counteract the negotiating strength of these customers, our profitability could decline.

 

We must identify changing consumer preferences and consumption trends and develop and offer food products to our customers that help meet those preferences and trends.

 

Consumer preferences evolve over time and our success depends on our ability to identify the tastes and dietary habits of consumers and offer products that appeal to those preferences. We need to continue to respond to these changing consumer preferences and support our customers in their efforts to evolve to meet those preferences. For example, as consumers focus on freshly prepared foods, some restaurants may choose to limit the frying capabilities of their kitchens. As a result, we would need to evolve our product offering to provide alternatives that work in such a preparation environment. In addition, our products contain carbohydrates, sodium, genetically modified ingredients, added sugars, saturated fats, and preservatives, the diet and health effects of which remain the subject of public scrutiny. We must continue to reformulate our products, introduce new products and create product extensions without a loss of the taste, texture, and appearance that consumers demand in value-added potato products. All of these efforts require significant research and development and marketing investments. If our products fail to meet consumer preferences or customer requirements, or we fail to introduce new and improved products on a timely basis, then the return on those investments will be less than anticipated, which could materially and adversely affect our business, financial condition, and results of operations.

 

A portion of our business is, and several of our growth strategies are, conducted through joint ventures that do not operate solely for our benefit.

 

We have built our company, in part, through the creation of joint ventures, some of which we do not control. In these relationships, we share ownership and management of a company that operates for the benefit of all owners, rather than our exclusive benefit. Through our extensive experience in operating a portion of our business through joint ventures, we understand that joint ventures often require additional resources and procedures for information sharing and decision-making. If our joint venture partners take actions that have negative impacts on the joint venture, or disagree with the strategies we have developed to grow these businesses, we may have limited ability to influence and mitigate those actions or decisions and our ability to achieve our growth strategies may be negatively impacted.

 

If we are unable to complete potential acquisitions that strategically fit our business objectives, integrate acquired businesses, or execute on large capital projects, our financial results could be materially and adversely affected.

 

From time to time, we evaluate acquisition candidates that may strategically fit our business objectives. Our acquisition activities may present financial, managerial, and operational risks. Those risks include: (i) diversion of

management attention from existing businesses, (ii) difficulties integrating personnel and financial and other systems, (iii) difficulties implementing effective control environment processes, (iv) adverse effects on existing business relationships with suppliers and customers, (v) inaccurate estimates of fair value made in the accounting for acquisitions and amortization of acquired intangible assets, which would reduce future reported earnings, (vi) potential loss of customers or key employees of acquired businesses, and (vii) indemnities and potential disputes with the sellers. If we are unable to complete acquisitions we may identify or successfully integrate and develop acquired businesses or execute on large capital projects, such as new production lines, our financial results could be materially and adversely affected.

 

New regulations imposed by the FDA or EFSA around acrylamide formation in french fried potato products could adversely affect us.

 

The regulation of food products, both within the United States and internationally, continues to be a focus for governmental scrutiny. The presence and/or formation of acrylamide in french fried potato products has become a global regulatory issue as both the FDA and the European Food Safety Authority (“EFSA”) have issued guidance to the food processing industry to work to reduce conditions that favor the formation of this naturally occurring compound. Acrylamide formation is the result of heat processing reactions that give “browned foods” their desirable flavor. Acrylamide formation occurs in many food types in the human diet, including but not limited to breads, toast, cookies, coffee, crackers, potatoes, and olives. The regulatory approach to acrylamide has generally been to encourage the industry to achieve as low as reasonably achievable content levels through process control (temperature) and material testing (low sugar and low asparagine). However, limits for acrylamide content have been established for some food types in the State of California, and point of sale consumer warnings are required if products exceed those limits. In addition, the EFSA has recently promulgated regulations establishing specific mitigation measures, sampling and analysis procedures and benchmark levels for acrylamide in certain food products. If the global regulatory approach to acrylamide becomes more stringent and additional legal limits are established, our manufacturing costs could increase. In addition, if consumer perception regarding the safety of our products is negatively impacted due to regulation, sales of our products could decrease.

 

If we fail to comply with the many laws and regulations applicable to our business, we may face lawsuits or incur significant fines and penalties.

 

Our facilities and products are subject to many laws and regulations administered by the U.S. Department of Agriculture, the FDA, the Occupational Safety and Health Administration, and other federal, state, local, and foreign governmental agencies relating to the processing, packaging, storage, distribution, advertising, labeling, quality, and safety of food products, the health and safety of our employees, and the protection of the environment. Our failure to comply with applicable laws and regulations could subject us to lawsuits, administrative penalties, and civil remedies, including fines, injunctions, and recalls of our products.

 

Our operations are also subject to extensive and increasingly stringent regulations administered by the Environmental Protection Agency, and comparable state agencies, which pertain to the discharge of materials into the environment and the handling and disposition of wastes. Failure to comply with these regulations can have serious consequences, including civil and administrative penalties and negative publicity. Changes in applicable laws or regulations or evolving interpretations thereof, including increased government regulations to limit carbon dioxide and other greenhouse gas emissions as a result of concern over climate change, may result in increased compliance costs, capital expenditures, and other financial obligations for us, which could affect our profitability or impede the production or distribution of our products, which could adversely affect our business, financial condition, and results of operations.

 

Litigation could expose us to significant costs and adversely affect our business, financial condition, and results of operations.

 

We are, or may become, party to various lawsuits and claims arising in the ordinary course of business, which may include lawsuits or claims relating to commercial liability, product recalls, product liability, product claims,

employment matters, environmental matters, or other aspects of our business. Litigation is inherently unpredictable, and although we may believe we have meaningful defenses in these matters, we may incur judgments or enter into settlements of claims that could have a material adverse effect on our business, financial condition, and results of operations. The costs of responding to or defending litigation may be significant and may divert the attention of management away from our strategic objectives. There may also be adverse publicity associated with litigation that may decrease customer confidence in our business, regardless of whether the allegations are valid or whether we are ultimately found liable. As a result, litigation may have a material adverse effect on our business, financial condition, and results of operations.

 

We may be subject to product liability claims and product recalls, which could negatively impact our relationships with customers and harm our business.

 

We sell food products for human consumption, which involves risks such as product contamination or spoilage, product tampering, other adulteration of food products, mislabeling, and misbranding. We may voluntarily recall or withdraw products from the market in certain circumstances, which would cause us to incur associated costs; those costs could be meaningful. We may also be subject to litigation, requests for indemnification from our customers, or liability if the consumption or inadequate preparation of any of our products causes injury, illness, or death. A significant product liability judgment or a widespread product recall may negatively impact our sales and profitability for a period of time depending on the costs of the recall, the destruction of product inventory, product availability, competitive reaction, customer reaction, and consumer attitudes. Even if a product liability claim is unsuccessful or is not fully pursued, the negative publicity surrounding any assertion that our products caused illness or injury could adversely affect our reputation with existing and potential customers and our corporate and brand image.

 

Additionally, as a manufacturer and marketer of food products, we are subject to extensive regulation by the FDA and other national, state and local government agencies. The Food, Drug & Cosmetic Act and the Food Safety Modernization Act and their respective regulations govern, among other things, the manufacturing, composition and ingredients, packaging and safety of food products. Some aspects of these laws use a strict liability standard for imposing sanctions on corporate behavior; meaning that no intent is required to be established. If we fail to comply with applicable laws and regulations, we may be subject to civil remedies, including fines, injunctions, recalls, or seizures, as well as criminal sanctions, any of which could have a material adverse effect on our business, financial condition, and results of operations.

 

Damage to our reputation as a trusted partner to customers and good corporate citizen could have a material adverse effect on our business, financial condition, and results of operations.

 

Our customers rely on us and our co-manufacturers to manufacture safe, high quality food products. Product contamination or tampering, the failure to maintain high standards for product quality, safety, and integrity, or allegations of product quality issues, mislabeling or contamination, even if untrue, may damage the reputation of our customers, and ultimately our reputation as a trusted industry partner. Damage to either could reduce demand for our products or cause production and delivery disruptions.

 

Our reputation could also be adversely impacted by any of the following, or by adverse publicity (whether or not valid) relating thereto: the failure to maintain high ethical, social, and environmental standards for our operations and activities; our research and development efforts; our environmental impact, including use of agricultural materials, packaging, energy use, and waste management; our failure to comply with local laws and regulations; our failure to maintain an effective system of internal controls; or our failure to provide accurate and timely financial information. Damage to our reputation or loss of customer confidence in our products for any of these or other reasons could result in decreased demand for our products and could have a material adverse effect on our business, financial condition, and results of operations, as well as require additional resources to rebuild our reputation.

 

Our results could be adversely impacted as a result of increased pension, labor and people-related expenses.

 

Inflationary pressures and any shortages in the labor market could increase labor costs, which could have a material adverse effect on our business, financial condition or results of operations. Our labor costs include the cost of providing employee benefits in the United States and foreign jurisdictions, including pension, health and welfare, and severance benefits. Changes in interest rates, mortality rates, health care costs, early retirement rates, investment returns, and the market value of plan assets can affect the funded status of our defined benefit plans and cause volatility in the future funding requirements of the plans. A significant increase in our obligations or future funding requirements could have a negative impact on our results of operations and cash flows from operations. Additionally, the annual costs of benefits vary with increased costs of health care and the outcome of collectively-bargained wage and benefit agreements.

 

We are significantly dependent on information technology, and we may be unable to protect our information systems against service interruption, misappropriation of data, or breaches of security.

 

We rely on information technology networks and systems, including the Internet, to process, transmit, and store electronic and financial information, to manage and support a variety of business processes and activities, and to comply with regulatory, legal, and tax requirements. Our information technology systems, some of which are dependent on services provided by third parties, may be vulnerable to damage, invasions, disruptions, or shutdowns due to any number of causes such as catastrophic events, natural disasters, fires, power outages, systems failures, telecommunications failures, security breaches, computer viruses, hackers, employee error or malfeasance, and other causes. Increased cybersecurity threats pose a potential risk to the security and viability of our information technology systems, as well as the confidentiality, integrity, and availability of the data stored on those systems. If we do not allocate and effectively manage the resources necessary to build and sustain the proper technology infrastructure and to maintain and protect the related automated and manual control processes, we could be subject to billing and collection errors, business disruptions, or damage resulting from security breaches. If any of our significant information technology systems suffer severe damage, disruption, or shutdown and our business continuity plans do not effectively resolve the issues in a timely manner, our product sales, financial condition, and results of operations may be materially and adversely affected, and we could experience delays in reporting our financial results. Any interruption of our information technology systems could have operational, reputational, legal, and financial impacts that may have a material adverse effect on our business, financial condition and results of operations.

 

In addition, if we are unable to prevent security breaches or unauthorized disclosure of non-public information, we may suffer financial and reputational damage, litigation or remediation costs, fines, or penalties because of the unauthorized disclosure of confidential information belonging to us or to our partners, customers or suppliers.

 

Misuse, leakage, or falsification of information could result in violations of data privacy laws and regulations, potentially significant fines and penalties, damage to our reputation and credibility, loss of strategic opportunities, and loss of ability to commercialize products developed through research and development efforts and, therefore, could have a negative impact on net sales. In addition, we may face business interruptions, litigation, and financial and reputational damage because of lost or misappropriated confidential information belonging to us, our current or former employees, or to our suppliers or customers, and may become subject to legal action and increased regulatory oversight. We could also be required to spend significant financial and other resources to remedy the damage caused by a security breach or to repair or replace networks and information systems.

 

There are inherent limitations on the effectiveness of our controls.

 

We do not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well-designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that resource constraints exist, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements

due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate due to changes in conditions or deterioration in the degree of compliance with policies or procedures. If our controls become inadequate, we could fail to meet our financial reporting obligations, our reputation may be adversely affected, our business, financial condition, and results of operations could be adversely affected, and the market price of our stock could decline.

 

If we are unable to attract and retain key personnel, our business could be materially and adversely affected.

 

Our success depends on our ability to attract and retain personnel with professional and technical expertise, such as agricultural and food manufacturing experience, as well as finance, marketing, and other senior management professionals. The market for these employees is competitive, and we could experience difficulty from time to time in hiring and retaining the personnel necessary to support our business. If we do not succeed in retaining our current employees and attracting new high-quality employees, our business could be materially and adversely affected.

 

Climate change, or legal, regulatory, or market measures to address climate change, may negatively affect our business and operations.

 

There is growing concern that carbon dioxide and other greenhouse gases in the atmosphere may have an adverse impact on global temperatures, weather patterns, the frequency and severity of extreme weather, and natural disasters. In the event that climate change has a negative effect on agricultural productivity, we may be subject to decreased availability or less favorable pricing for certain commodities that are necessary for our products, such as potatoes and oils. In addition, water is an important part of potato processing. We may be subjected to decreased availability or less favorable pricing for water, which could impact our manufacturing and distribution operations. The increasing concern over climate change also may result in more regional, federal, and/or global legal and regulatory requirements to reduce or mitigate the effects of greenhouse gases, as well as more stringent regulation of water rights. In the event that such regulation is enacted and is more aggressive than the sustainability measures that we are currently undertaking to monitor our emissions, improve our energy efficiency, and reduce and reuse water, we may experience significant increases in our costs of operation and delivery. As a result, climate change could negatively affect our business and operations.

 

Deterioration of general economic conditions could harm our business and results of operations.

 

Our business, financial condition and results of operations may be adversely affected by changes in national or global economic conditions, including interest rates, access to capital markets, consumer spending rates, energy availability and costs (including fuel surcharges), and the effects of governmental initiatives to manage economic conditions.

 

Volatility in financial markets and deterioration of national and global economic conditions could impact our business and operations in a variety of ways, including as follows:

 

 

 

 

 

 

Impairment in the carrying value of goodwill or other intangibles could result in the incurrence of impairment charges and negatively impact our net worth.

 

As of May 27, 2018, we had goodwill of $135.1 million and other intangibles of $35.4 million. The net carrying value of goodwill represents the fair value of acquired businesses in excess of identifiable assets and liabilities as of the acquisition date (or subsequent impairment date, if applicable). The net carrying value of other intangibles represents the fair value of trademarks, customer relationships, and other acquired intangibles as of the acquisition date (or subsequent impairment date, if applicable), net of accumulated amortization. Goodwill and other acquired intangibles expected to contribute indefinitely to our cash flows are not amortized, but must be evaluated by management at least annually for impairment. Amortized intangible assets are evaluated for impairment whenever events or changes in circumstance indicate that the carrying amounts of these assets may not be recoverable. Impairments to goodwill and other intangible assets may be caused by factors outside our control, such as increasing competitive pricing pressures, lower than expected revenue and profit growth rates, changes in industry earnings before interest, taxes, depreciation and amortization (“EBITDA”) multiples, changes in discount rates based on changes in cost of capital (interest rates, etc.), or the bankruptcy of a significant customer, and could result in the incurrence of impairment charges and negatively impact our net worth.

 

We have a limited operating history as an independent public company, and our historical financial information is not necessarily indicative of our future financial condition, results of operations, or cash flows nor do they reflect what our financial condition, results of operations or cash flows would have been as an independent public company during the periods presented.

 

Our historical financial statements do not necessarily reflect what our financial condition, results of operations, or cash flows would have been as an independent public company during certain of the periods presented and is not necessarily indicative of our financial condition, results of operations, or cash flows for future periods. This is primarily a result of the following factors:

 

 

 

 

We are subject to significant restrictions under a tax matters agreement.

 

In connection with the spinoff, we entered into a tax matters agreement with Conagra. The tax matters agreement generally prohibits us, during the two-year period following the spinoff, from taking certain actions that could cause the spinoff and certain related transactions to fail to qualify as tax-free transactions. These restrictions include:

 

 

 

 

 

 

In addition, during the five-year period following the spinoff, we may not retire, repurchase, or significantly modify our senior notes. Further, more generally, we may not take any action that could reasonably be expected to cause the spinoff and certain related transactions to fail to qualify as tax-free transactions under Section 368(a)(1)(D) and Section 355 of the Code. If we take any of the actions above and the actions result in tax-related losses to Conagra, we generally will be required to indemnify Conagra for such tax-related losses under the tax matters agreement. Due to these restrictions and indemnification obligations under the tax matters agreement, we may be limited in our ability to pursue strategic transactions, equity or convertible debt financings or other transactions that may otherwise be in our best interests. Also, our potential indemnity obligation to Conagra might discourage, delay or prevent a change of control that our stockholders may consider favorable.

 

If the spinoff is taxable to Conagra as a result of a breach by us of any covenant or representation made by us in the tax matters agreement, we will generally be required to indemnify Conagra; the obligation to make a payment on this indemnification obligation could have a material adverse effect on us.

 

It was intended that the spinoff, together with certain related transactions, would qualify as a tax-free “reorganization” within the meaning of Section 368(a)(1)(D) of the Code and a tax-free distribution within the meaning of Section 355 of the Code. In connection with the spinoff, Conagra received an opinion of tax counsel to the effect that those transactions will qualify for their intended tax treatment. However, an opinion of tax counsel does not preclude the Internal Revenue Service (“IRS”) or the courts from adopting a contrary position. The tax opinion relied on certain representations, covenants, and assumptions, including those relating to our and Conagra’s past and future conduct; if any of those representations, covenants or assumptions is inaccurate, the tax consequences of the spinoff could differ from the intended tax treatment. If the spinoff and/or certain related transactions fail to qualify for tax-free treatment, for any reason, Conagra and/or holders of its common stock would be subject to tax as a result of the spinoff and certain related transactions.

 

If the spinoff and/or the related transactions are not treated as tax-free transactions or are taxable to Conagra due to a breach by us (or any of our subsidiaries) of any covenant or representation made by us in the tax matters agreement, we will generally be required to indemnify Conagra for all tax-related losses suffered by Conagra in connection with the spinoff. In addition, we will not control the resolution of any tax contest relating to taxes suffered by Conagra in connection

with the spinoff, and we may not control the resolution of tax contests relating to any other taxes for which we may ultimately have an indemnity obligation under the tax matters agreement. In the event that Conagra suffers tax-related losses in connection with the spinoff that must be indemnified by us under the tax matters agreement, the indemnification liability could have a material adverse effect on us.

 

We are subject to continuing contingent liabilities following the spinoff, including potential indemnification liabilities to Conagra, and these liabilities could materially and adversely affect our business, financial condition, results of operations, and cash flows.

 

In connection with the spinoff, we entered into a separation and distribution agreement with Conagra that provides for, among other things, the principal corporate transactions required to effect the spinoff, certain conditions to the spinoff, and provisions governing the relationship between our company and Conagra with respect to and resulting from the spinoff. Among other things, the separation and distribution agreement provides for indemnification obligations designed to make us financially responsible for substantially all liabilities that may exist relating to the Lamb Weston business, whether incurred prior to or after the spinoff, and whether known or unknown at the time of the spinoff, as well as those obligations of Conagra assumed by us pursuant to the separation and distribution agreement. If we are required to indemnify Conagra under the circumstances set forth in the separation and distribution agreement, or meaningful unknown liabilities surface, we may be subject to substantial liabilities.

 

In addition, under the Code and applicable Treasury regulations, each corporation that was a member of the Conagra consolidated tax reporting group during any taxable period or portion of any taxable period ending on or before the completion of the spinoff is jointly and severally liable for the federal income tax liability of the entire Conagra consolidated tax reporting group for that taxable period. Similar rules may apply for state, local, and non-U.S. tax purposes. In addition, the tax matters agreement with Conagra allocates the responsibility for prior period taxes of any Conagra consolidated, combined, unitary or other tax reporting group between us and Conagra. However, if Conagra is unable to pay any prior period taxes for which it is responsible under the tax matters agreement, we could be required to pay the entire amount of those taxes, which could materially and adversely affect our business, financial condition, results of operations, and cash flows.

 

In connection with the spinoff, Conagra agreed to indemnify us for certain liabilities. However, there can be no assurance that the indemnity will be sufficient to insure us against the full amount of such liabilities, or that Conagra’s ability to satisfy its indemnification obligations will not be impaired in the future.

 

Pursuant to the separation and distribution agreement, Conagra agreed to indemnify us for certain liabilities. However, third parties could seek to hold us responsible for any of the liabilities that Conagra has agreed to retain, and there can be no assurance that the indemnity from Conagra will be sufficient to protect us against the full amount of those liabilities, or that Conagra will be able to fully satisfy its indemnification obligations. Moreover, even if we ultimately succeed in recovering from Conagra any amounts for which we are held liable, we may be temporarily required to bear these losses ourselves. If Conagra is unable to satisfy its indemnification obligations, the underlying liabilities could have a material adverse effect on our business, financial condition, results of operations, or cash flows.

 

Further, Conagra’s insurers may deny coverage to us for liabilities associated with occurrences prior to the spinoff. Even if we ultimately succeed in recovering from such insurance providers, we may be required to temporarily bear such loss of coverage.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

ITEM 2. PROPERTIES

 

We are headquartered in Eagle, Idaho and at May 27, 2018, we own and lease operating plants, office and support facilities, and farms in the following locations:

 

 

We use our farms as a source of raw materials, to better understand the costs of growing potatoes, and to deploy agronomic research. Our facilities vary in age and condition, and each of them has an active maintenance program to ensure a safe operating environment and to keep the facilities in good condition. We believe all our buildings are in satisfactory operating condition to conduct our business as intended.

 

Our manufacturing assets are shared across all reporting segments. Therefore, we do not identify or allocate assets by operating segment. For more information, see Note 13, Segments, of the Notes to Combined and Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” of this Form 10-K. 

 

In addition to the facilities noted above, our joint ventures own or lease warehouses and distribution facilities in Canada, China, the Netherlands, the United Kingdom, Austria, Russia, and the United States.

 

 

ITEM 3. LEGAL PROCEEDINGS

 

For information regarding our legal proceedings, see Note 14, Commitments, Contingencies, Guarantees, and Legal Proceedings, of the Notes to Combined and Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data" of this Form 10-K.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

None.

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Our common stock is listed on the NYSE under the ticker symbol “LW.” At July 16, 2018, there were 13,439 holders of record of our common stock. The majority of holders of Lamb Weston common stock are “street name” or beneficial holders, whose shares of record are held by banks, brokers, and other financial institutions. Information regarding the market price of our common stock and dividends declared since the Separation is included in Note 15, Quarterly Financial Data (Unaudited), of the Notes to Combined and Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data" of this Form 10-K.

 

Dividend Policy

 

We expect to continue to pay regular cash dividends, although there is no assurance as to the timing or level of future dividend payments. The declaration of dividends is subject to the discretion of our Board of Directors and depends on various factors, including our net earnings, capital requirements, financial condition, future prospects and other factors that our Board of Directors deems relevant to its analysis and decision making.

 

Purchases of Equity Securities by the Issuer

 

The following table presents information related to our repurchases of common stock made during the thirteen weeks ended May 27, 2018:

 

Performance Graph

 

The following graph and table compares the cumulative total return on our common stock with the cumulative total return of the Standard & Poor’s (“S&P”) 400 Midcap Index and the S&P Packaged Food Index, which we consider to be our peer group. This graph covers the period from November 10, 2016 (the first day our common stock began trading on NYSE) through May 25, 2018 (the last trading day of our fiscal year). The graph and table assume that $100 was invested in our common stock, the S&P 400 Midcap Index, and the S&P Packaged Food Index on November 10, 2016, and that all dividends were reinvested.

 

 

 

The above performance graph and other information furnished under this Part II, Item 5 of this Form 10-K shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C, or to the provisions of Section 18 of the Securities Exchange Act of 1934.

ITEM 6. SELECTED FINANCIAL DATA

 

The following table sets forth selected historical financial data of Lamb Weston (dollars in millions, except per share data). The information contained in the table should be read in conjunction with the disclosures in "Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations" and "Part II, Item 8. Financial Statements and Supplementary Data" of this Form 10-K.

 

 

 

 

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis is intended to provide a summary of significant factors relevant to our financial performance and condition. The discussion and analysis should be read together with our combined and consolidated financial statements and related notes in “Part II, Item 8. Financial Statements and Supplementary Data" of

this Form 10-K. Results for the fiscal year ended May 27, 2018 are not necessarily indicative of results that may be attained in the future.

 

Overview

 

Lamb Weston, along with its joint venture partners, is a leading global producer, distributor, and marketer of value-added frozen potato products. We, along with our joint venture partners, are the number one supplier of value-added frozen potato products in North America. We are also a leading supplier of value-added frozen potato products internationally, with a strong and growing presence in high-growth emerging markets. We, along with our joint venture partners, 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.

 

On November 9, 2016, we separated from Conagra and became an independent publicly traded company through the pro rata distribution by Conagra of 100% of our outstanding common stock to Conagra stockholders. In connection with the Separation, Conagra transferred substantially all of the assets and liabilities and operations of the Lamb Weston business to us. Combined financial statements prior to the Separation were prepared on a stand-alone basis and were derived from Conagra’s consolidated financial statements and accounting records and reflect our financial position, results of operations, comprehensive income and cash flows as our business was operated as part of Conagra prior to the Separation and includes allocations for a portion of Conagra’s shared corporate general and administrative expenses. The combined financial position, results of operations, and cash flows as of dates and for periods prior to the Separation may not be indicative of what our financial position, results of operations, and cash flows would have been as a separate stand-alone public company during the periods presented, nor are they indicative of what our financial position, results of operations, and cash flows may be in the future.

 

Management’s discussion and analysis of our results of operations and financial condition, which we refer to in this filing as “MD&A,” is provided as a supplement to the combined and consolidated financial statements and related notes included elsewhere in this Form 10-K 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, Adjusted EBITDA including unconsolidated joint ventures and Adjusted Diluted EPS) that is prepared using non-GAAP financial measures. See “Reconciliations of Non-GAAP Financial Measures to Reported Amounts” below for the definitions of Adjusted EBITDA, Adjusted EBITDA including unconsolidated joint ventures and Adjusted Diluted EPS, and a reconciliation of these non-GAAP financial measures to net income or diluted earnings per share.

 

Executive Summary

 

We had strong performance in fiscal 2018. Our financial results reflected the favorable operating environment that the Company has enjoyed over the past couple years. Our results also reflect our focus on delivering our strategic and operational objectives through an ongoing commitment to support our customers’ growth by investing in additional capacity, maintaining high levels of service, and developing innovative products and limited time offerings. Specifically, in fiscal 2018, compared with fiscal 2017:

 

 

Demand for frozen potato products continues to grow around the world. We expect to meet the increase in demand by investing in additional capacity. We began operating a new production line in Richland, Washington and Boardman, Oregon during the third quarter of fiscal 2018 and 2017, respectively, and we expect to begin operating a new production line in Hermiston, Oregon by the end of the fourth quarter of fiscal 2019. Additionally, in the fourth quarter of fiscal 2018, our Lamb-Weston/Meijer joint venture, in conjunction with a partner in the Russian Federation, initiated production at a newly-constructed french fry processing facility in Lipetsk, a special economic zone in south Moscow. In June 2017, our Lamb-Weston/Meijer joint venture also acquired the potato processing business of Oerlemans Foods, which included a potato processing facility located in Broekhuizenvorst, the Netherlands.

 

Markets

 

We operate in the global value-added frozen potato products industry, with the majority of our sales derived from products sold to customers in North America, and the remainder sold to customers primarily in Asia, Europe, Latin America, Oceania and the Middle East.

 

In general, demand for frozen potato products grew steadily in fiscal 2018. In North America, volume demand growth was driven by quick service restaurant chains (“QSRs”) and casual dining restaurant chains. Internationally,

demand growth was driven by increased access to consumers through continued expansion in these markets by both North America-based QSRs, local QSRs, and restaurant chains. In addition, in emerging markets, demand growth was driven by increased affordability due to higher per capita incomes and increased appeal of Western-style food offerings and diets.

 

In this environment of growing volume demand, there was limited available capacity to produce frozen potato products in fiscal 2018, especially in North America, which led to increased prices across the industry.

 

Outlook 

 

In fiscal 2019, we expect the operating environment to be generally favorable given the continued growth in volume demand and high industry manufacturing capacity utilization levels. A number of manufacturers, including Lamb Weston, have announced intentions to add production capacity over the next five years, largely in Europe, North America and China, which will likely ease the industry’s near-term production constraints. In addition, compared with fiscal 2018, we expect a higher rate of inflation for many of our commodity, manufacturing, transportation and warehousing costs. We also expect significantly higher selling, general and administrative costs as a result of investments in our information systems and enterprise resource planning infrastructure, as well as sales, marketing, innovation, operations and other functional capabilities, designed to drive operating efficiencies and support future growth.

 

Results of Operations

 

We have four reportable segments: Global, Foodservice, Retail, and Other. For each period presented, we report net sales and product contribution margin by segment. Net sales and product contribution margin are the primary measures reported to our chief operating decision maker for purposes of allocating resources to our segments and assessing their performance. We define product contribution margin as net sales less cost of sales and advertising and promotion expenses. Product contribution margin excludes general corporate expenses and interest expense because management believes these amounts are not directly associated with segment performance for the period. For additional information on our reportable segments, see Note 13, Segments, of the Notes to Combined and Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” in this Form 10-K.

 

Fiscal Year Ended May 27, 2018 Compared to Fiscal Year Ended May 28, 2017

 

Net Sales and Product Contribution Margin (dollars in millions)

 

 

Net Sales

 

Lamb Weston’s net sales for fiscal 2018 were $3,423.7 million, an increase of $255.7 million, or 8%, compared with fiscal 2017. Net sales in fiscal 2018 reflect a 6% increase in price/mix and 2% increase in volume growth, with growth in each core operating segment.

 

Global net sales increased $119.4 million, or 7%, to $1,744.2 million, compared with $1,624.8 million in fiscal 2017. Net sales in fiscal 2018 reflect a 5% increase in price/mix associated with price increases in both domestic and international markets, as well as improved customer and product mix. Sales volumes increased 2%, primarily driven by

organic growth and new business with major restaurant chains in North America. While net sales in international markets increased nominally, sales volumes declined as we chose to improve customer and product mix, as well as lower shipments to certain export markets.

 

Foodservice net sales increased $69.1 million, or 7%, to $1,099.1 million, compared with $1,030.0 million in fiscal 2017. Net sales in fiscal 2018 reflect a 6% increase related to favorable pricing, as well as actions to improve customer and product mix. Sales volume increased 1%, which was primarily related to growth of sales of Lamb Weston-branded and operator label products to small and mid-sized restaurant chains, partially offset by lower sales volume of distributor label products.

 

Retail net sales increased $64.3 million, or 17%, to $449.2 million, compared with $384.9 million in fiscal 2017. Net sales in fiscal 2018 reflect a 12% increase in sales volume, driven by distribution gains of Grown in Idaho and other branded products, as well as increased shipments of private label products. Price/mix increased 5%, reflecting higher prices across the branded and private label portfolios, as well as improved mix, partially offset by higher trade investments to support expanded distribution of Grown in Idaho branded products.

 

Net sales in our Other segment increased $2.9 million, or 2%, to $131.2 million, compared with $128.3 million in fiscal 2017, primarily due to favorable product mix in our vegetable business.

 

Product Contribution Margin

 

Global product contribution margin increased $37.1 million, or 11%, to $375.7 million in fiscal 2018, as a result of favorable price/mix and volume growth. Global cost of sales was $1,361.8 million, or 6% higher in fiscal 2018, as compared to fiscal 2017, largely due to higher volume, input, manufacturing, transportation and warehousing cost inflation, higher depreciation expense primarily related to our new french fry production line in Richland, Washington, and higher incentive compensation costs, partially offset by supply chain efficiency savings. Advertising and promotion spending was $0.9 million higher in 2018, as compared to fiscal 2017.

 

Foodservice product contribution margin increased $35.2 million, or 11%, to $365.9 million in fiscal 2018, primarily as a result of favorable price/mix. Cost of sales was $724.7 million, or 5% higher in fiscal 2018, as compared to fiscal 2017, largely due to input, manufacturing, transportation and warehousing cost inflation, higher depreciation expense primarily related to our new french fry production line in Richland, Washington, and higher compensation costs, partially offset by supply chain efficiency savings. Advertising and promotion spending was $1.6 million higher in fiscal 2018, compared with fiscal 2017.

 

Retail product contribution margin increased $9.7 million, or 13%, to $87.3 million in fiscal 2018 due to favorable price/mix and higher sales volumes. Cost of sales was $346.0 million, or 16% higher in fiscal 2018 as compared to fiscal 2017, largely due to higher volume and transportation, warehousing, input and manufacturing cost inflation. Advertising and promotion spending was $6.5 million higher in fiscal 2018, compared with fiscal 2017, as we invested behind the introduction of Grown In Idaho branded products.

 

Other product contribution margin increased $9.7 million to $19.0 million in fiscal 2018, as compared to $9.3 million in fiscal 2017. The increase was primarily due to a change in unrealized mark-to-market adjustments of approximately $4 million related to our commodity option contracts and an expense in the prior year related to a recall of some vegetable products that were produced by a third party.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased $38.9 million, or 15%, in fiscal 2018 compared with fiscal 2017. Fiscal 2018 and 2017, included $8.7 million ($5.7 million after-tax) and $26.5 million ($16.7 million after-tax) of expenses for costs related to the Separation, primarily related to professional fees and other employee-related costs. Fiscal 2017 also included a $3.1 million ($2.0 million after-tax) non-cash gain on assets. Excluding these items, fiscal 2018,

selling, general and administrative expenses increased $53.6 million, or 23%, versus the prior year largely due to incremental costs associated with being a stand-alone public company, higher incentive compensation costs based on operating performance, and a $9.0 million increase in advertising and promotional support. In addition, the increase in selling, general and administrative expenses also includes approximately $5 million to establish a new Lamb Weston charitable foundation, and approximately $4 million of costs related to transitioning our Foodservice segment go-to-market strategy from a broker-led sales model to a direct sales model.

 

Interest Expense, Net

 

Interest expense, net was $108.8 million in fiscal 2018, an increase of $47.6 million compared with fiscal 2017. The increase in interest expense, net was the result of recognizing interest expense for a full-year for the debt incurred in connection with the Separation, compared with recognizing approximately only seven months of interest expense on this debt during fiscal 2017.

 

For more information, see Note 9, Debt and Financing Obligations, of the Notes to Combined and Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” in this Form 10-K. For the period prior to the Separation, interest expense was included for only the legal entities that comprised the Lamb Weston business, and did not include any allocated interest expense from Conagra.

 

Income Taxes

 

 

The Tax Act decreased income tax expense by $64.7 million; $36.3 million of the decrease related to a lower U.S. corporate tax rate and $28.4 million related to the provisional impacts of the Tax Act that was enacted in December 2017. For further information on the Tax Act and its impact, see Note 4, Income Taxes, of the Notes to Combined and Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” in this Form 10-K.

 

Equity Method Investment Earnings

 

We conduct meaningful business through unconsolidated joint ventures and include our share of the earnings based on our economic ownership interest in them. Lamb Weston’s share of earnings from its equity method investments was $83.6 million and $53.3 million for fiscal 2018 and 2017, respectively. These amounts included a nominal unrealized loss related to mark-to-market adjustments associated with currency and commodity hedging contracts in the current year, and a $3.6 million gain related to the contracts in fiscal 2017. Excluding these adjustments, earnings from equity method investments increased $33.9 million, driven by solid operating results in Europe and the U.S., including lower raw potato and production costs in Europe, volume growth, a $5.4 million foreign currency translation benefit, and an approximate $4 million gain related to a divestiture of a non-core business. The increase was partially offset by lower price/mix in Europe. For more information about our joint ventures, see Note 6, Investments in Joint Ventures, of the Notes to Combined and Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” in this Form 10-K.

Fiscal Year Ended May 28, 2017 Compared to Fiscal Year Ended May 29, 2016

 

Net Sales and Product Contribution Margin (dollars in millions)

 

 

Net Sales

 

Lamb Weston’s net sales for fiscal 2017 were $3,168.0 million, an increase of $174.2 million, or 6%, compared with fiscal 2016. Net sales in fiscal 2017 reflect a 4% increase in price/mix and volume growth of 2%, with growth across our core operating segments.

 

Global net sales increased $75.4 million, or 5%, to $1,624.8 million, compared with $1,549.4 million in fiscal 2016. Net sales in fiscal 2017 reflect a 4% increase in sales volume, driven by growth domestically, which included organic growth and new business with major restaurant chains, as well as growth in international markets. Additionally, net sales in fiscal 2017 reflect a 1% increase in price/mix associated with price increases in both domestic and international markets, as well as actions to improve customer and product mix.

 

Foodservice net sales increased $84.0 million, or 9%, to $1,030.0 million, compared with $946.0 million in fiscal 2016. Net sales in fiscal 2017 reflect an 8% increase related to favorable pricing, as well as actions to improve customer and product mix. Sales volume increased 1%, which related to growth of small and mid-sized restaurant chain operators, as well as regional and independent food distributors.

 

Retail net sales increased $12.8 million, or 3%, to $384.9 million, compared with $372.1 million in fiscal 2016. Net sales in fiscal 2017 reflect a 2% increase related to favorable pricing and customer mix changes due to the increase of licensed brands and trade efficiencies. Sales volume increased 1%, primarily driven by growth of licensed and private label products.

 

Net sales in our Other segment increased $2.0 million, or 2%, to $128.3 million, compared with $126.3 million in fiscal 2016, primarily due to favorable product mix in our vegetable business.

 

Product Contribution Margin

 

Global product contribution margin increased $45.4 million, or 15%, to $338.6 million in fiscal 2017, as a result of favorable price/mix, supply chain efficiency savings, and volume growth. Global cost of sales was $1,280.4 million, or 3% higher in fiscal 2017, as compared to fiscal 2016, largely due to higher volume, partially offset by supply chain efficiency savings. Advertising and promotion spending was $1.1 million lower in 2017, as compared to fiscal 2016, driven by the timing of costs related to our global rebranding in fiscal 2016.

 

Foodservice product contribution margin increased $77.7 million, or 31%, to $330.7 million in fiscal 2017 as a result of favorable price/mix, supply chain efficiency savings, and volume growth. Cost of sales was $692.4 million, or 1% higher in fiscal 2017, as compared to fiscal 2016, largely due to higher volume, partially offset by supply chain efficiency savings. Advertising and promotion spending was $0.3 million lower in fiscal 2017, compared with fiscal 2016.

 

Retail product contribution margin increased $8.5 million, or 12%, to $77.6 million due to favorable price/mix. Cost of sales was $297.8 million, or 2% higher in fiscal 2017 as compared to fiscal 2016, largely due to higher volume and higher supply chain costs. Advertising and promotion spending was $1.7 million lower in fiscal 2017, compared with fiscal 2016, due to the timing of marketing and promotional spending.

 

Other product contribution margin decreased $11.6 million, or 56%, to 9.3 million in fiscal 2017, due primarily to the unrealized mark-to-market losses related to our commodity option contracts and lower sales volumes.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses decreased $28.0 million, or 10%, to $260.5 million in fiscal 2017, compared with fiscal 2016. Fiscal 2017 included $26.5 million ($16.7 million after-tax) of expenses for costs related to the Separation, primarily related to professional fees, and a $3.1 million ($2.0 million after-tax) non-cash gain on assets. Fiscal 2016 included $64.9 million ($45.3 million after-tax) of comparability items, primarily comprised of $59.5 million of actuarial losses related to a pension liability and $5.3 million of costs related to the spinoff from Conagra. Excluding these costs for each fiscal year, and the non-cash gain on assets, in fiscal 2017, selling, general and administrative expenses increased $13.5 million, or 6%, versus the prior year largely due to incremental costs associated with being a stand-alone public company, as well as higher incentive compensation costs attributable to our operating performance.

 

Interest Expense, Net

 

Interest expense, net was $61.2 million in fiscal 2017, an increase of $55.3 million compared with fiscal 2016. The increase in interest expense, net was the result of the debt incurred in connection with the Separation. For more information, see Note 9, Debt and Financing Obligations, of the Notes to Combined and Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” in this Form 10-K. For the period prior to the Separation, interest expense was included for only the legal entities that comprised the Lamb Weston business, and did not include any allocated interest expense from Conagra.

 

Income Taxes

 

Income tax expense for fiscal 2017 and 2016 was $170.2 million and $144.5 million, respectively. The effective tax rate (calculated as the ratio of income tax expense to pre-tax income, inclusive of equity method investment earnings) was approximately 33% for both fiscal 2017 and 2016. The effective tax rate varied from the U.S. federal statutory tax rate of 35% principally due to the impact of U.S. state taxes, the domestic manufacturers’ deduction, foreign taxes, and other permanent differences.

 

Equity Method Investment Earnings

 

Lamb Weston’s share of earnings from its equity method investments was $53.3 million and $71.7 million for fiscal 2017 and 2016, respectively. Equity method investment earnings for fiscal 2017 were lower due to a $17.7 million non-cash gain related to the settlement of a pension plan of Lamb-Weston/Meijer in fiscal 2016. In fiscal 2017, the effect of higher raw potato costs in Europe were essentially offset by higher pricing, cost savings initiatives and a $3.6 million unrealized gain related to mark-to-market adjustments associated with currency and commodity hedging contracts. For more information about our joint ventures, see Note 6, Investments in Joint Ventures, of the Notes to Combined and Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” in this Form 10-K.

 

Liquidity and Capital Resources

 

In fiscal 2018, we generated $481.2 million of operating cash flow and made $309.0 million of capital expenditures, which included expenditures for significant expansions at our Boardman, Oregon and Richland, Washington facilities. At May 27, 2018, we had $55.6 million of cash and cash equivalents compared to $57.1 million at May 28, 2017. Additionally, we had $496.6 million of available borrowing capacity on our revolving credit facility at May 27, 2018. Currently, our primary uses of cash are for operations, capital expenditures, dividends on our common stock, debt service and income tax payments. The Tax Act enacted in December 2017, imposes a tax on all previously untaxed foreign earnings. As a result, we recognized a provisional transition tax expense of $11.5 million, which will primarily be paid over the next eight years.

 

We believe that net cash generated from operating activities, cash on hand, available borrowings under our revolving credit facility, and available capital through access to capital markets will be adequate to meet our liquidity and capital requirements, including payment of any dividends on our common stock declared, for at least the next twelve months.

 

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 (dollars in millions):

 

 

Operating Activities

 

Fiscal 2018 Compared with Fiscal 2017

 

The major components of cash provided by operations are earnings from operations adjusted for non-cash income and expense items and changes in working capital. Cash generated from operating activities increased $34.3 million to $481.2 million in fiscal 2018, compared with $446.9 million in fiscal 2017. Earnings from continuing operations, adjusted for non-cash income and expense and other items, increased $91.4 million primarily due to favorable price/mix, and volume. Changes in operating assets and liabilities used $57.1 million more cash in fiscal 2018, compared with 2017. The decrease in cash provided by changes in operating assets and liabilities was driven primarily by higher accounts receivable levels in fiscal 2018, compared to fiscal 2017 due to increased sales and timing of collections, the timing of payments for accrued expenses relating to employee compensation and accrued interest in fiscal 2018, and the timing of payments for accounts payable. These cash outflows were offset partially by lower payments for income taxes, primarily related to the Tax Act.

 

Fiscal 2017 Compared with Fiscal 2016

 

Cash generated from operating activities increased $64.6 million to $446.9 million in fiscal 2017, compared with $382.3 million in fiscal 2016. Earnings from continuing operations, adjusted for non-cash income and expense and other items, increased $78.3 million due to favorable price/mix, supply chain efficiency savings, and volume growth. Cash

provided by operating assets and liabilities decreased $13.7 million in fiscal 2017, compared with fiscal 2016. The decrease in cash provided by changes in operating assets and liabilities was driven primarily by more cash required for taxes based on operating performance, a build-up of inventory ahead of planned production outages to implement capital projects, and an increase in prepaid expenses and other current assets related to the timing of grower prepayments, partially offset by increases in accounts payable and accrued expenses, which related primarily to higher incentive compensation costs attributable to our operating performance.

 

Investing Activities

 

Fiscal 2018 Compared with Fiscal 2017

 

Investing activities used $306.8 million of cash in fiscal 2018, compared with $285.3 million in fiscal 2017. These expenditures include plant capacity expansions at our Richland, Washington and Boardman, Oregon facilities.

 

We expect capital investments in fiscal 2019 to be approximately $360 million, which excludes acquisitions, but includes approximately $200 million to complete the construction of the 300 million pound french fry production line in Hermiston, Oregon, which is expected to be operational in May 2019. These expenditures could increase or decrease as a result of a number of factors, including our financial results, future economic conditions, and our regulatory compliance requirements. At May 27, 2018, we had commitments for capital expenditures of $158.6 million. In June 2018, we provided notice to Ochoa of our exercise of a call option to purchase Ochoa’s interest in Lamb Weston BSW. We expect to pay approximately $65 million and will consummate the transaction as soon as practicable. We believe that cash-on-hand combined with cash flows from operations will be sufficient to fund these commitments.

 

Fiscal 2017 Compared with Fiscal 2016

 

Investing activities used $285.3 million of cash in fiscal 2017, compared with $144.3 million in fiscal 2016. The increase related primarily to our plant capacity expansions at our Boardman, Oregon and Richland, Washington facilities in fiscal 2017. The chopped and formed production line in Boardman, Oregon started up in the third quarter of fiscal 2017.

 

Financing Activities

 

Fiscal 2018 Compared with Fiscal 2017

 

During fiscal 2018, cash used for financing activities totaled $178.9 million, compared with cash used for financing activities of $142.0 million in fiscal 2017. During fiscal 2018, financing activities primarily related to the payment of $110.2 million in dividends on our common stock, $39.2 million of debt payments, primarily scheduled payments under our term loan facility, distributions paid to noncontrolling interest of $14.6 million, and $14.4 million of payments related to short-term borrowings. We had no net transfers to Conagra in fiscal 2018, compared with $38.8 million of net transfers in fiscal 2017.

 

During fiscal 2017, cash used for financing activities primarily related to the Separation. In fiscal 2017, we issued $2,341.0 million of debt in connection with the Separation, of which $1,542.9 million of proceeds were distributed directly to Conagra (including $25.4 million that Conagra used to pay debt issuance costs) and are considered a noncash financing activity for Lamb Weston. We received $798.1 million of cash proceeds from the debt issuance. We used the $798.1 million of proceeds, together with borrowings on our revolving credit facility, to fund an $823.5 million cash payment to Conagra on the Separation Date. We paid $27.4 million of dividends to common stockholders, $12.3 million of debt issuance costs, and $2.8 million of net short-term borrowings. We made cash distributions to noncontrolling interest of $12.2 million and $23.8 million of debt repayments in fiscal 2017.

 

For more information about our debt, including among other items, interest rates, maturity dates, and covenants, see Note 9, Debt and Financing Obligations, of the Notes to the Combined and Consolidated Financial Statements in “Part

II, Item 8. Financial Statements and Supplementary Data” of this Form 10-K. At May 27, 2018, we were in compliance with the financial covenant ratios and other covenants contained in the Credit Agreement.

 

Fiscal 2017 Compared with Fiscal 2016

 

During fiscal 2017, cash used for financing activities totaled $142.0 million, compared with $232.8 million during fiscal 2016. The year-over-year change in financing activities primarily related to the Separation in fiscal 2017, while in fiscal 2016, cash was primarily used for transfers to Conagra, as we were part of Conagra’s cash management system through the Separation Date. We had $38.8 million of net transfers to Conagra in fiscal 2017, compared with $236.8 million of net transfers in fiscal 2016.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements as of May 27, 2018 that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures, or capital resources.

 

Investments in Joint Ventures

 

Lamb Weston has interests in certain entities that we have determined to be variable interest entities, but for which we are not the primary beneficiary. We do not consolidate the financial statements of these entities. For more information about our investments in joint ventures, see Note 6, Investments in Joint Ventures, of the Notes to the Combined and Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” of this Form 10-K.

 

Obligations and Commitments

 

As part of our ongoing operations, we enter into arrangements that obligate us to make future payments under contracts such as lease agreements, debt agreements, potato supply agreements, and unconditional purchase obligations (i.e., obligations to transfer funds in the future for fixed or minimum quantities of goods or services at fixed or minimum prices). The unconditional purchase obligation arrangements are entered into in the normal course of business in order to ensure adequate levels of sourced product are available.

 

A summary of our contractual obligations as of May 27, 2018, were as follows. The expected timing of payments of the obligations in the table are estimated based on current information. Timing of payments and actual amounts paid may be different, depending on the time of receipt of goods or services, or changes to agreed-upon amounts for some obligations.

 

 

 

 

 

 

 

 

 

 

 

For the majority of restricted stock units (“RSUs”) granted, the number of shares of common stock issued on the date the RSUs vest is net of the minimum statutory withholding requirements that we pay in cash to the appropriate taxing authorities on behalf of our employees. The obligation to pay the relevant taxing authority is excluded from the table above, as the amount is contingent upon continued employment. In addition, the amount of the obligation is unknown, as it is based in part on the market price of our common stock when the awards vest.

 

Although we expect to pay approximately $65 million to purchase Ochoa’s interest in Lamb Weston BSW, such amount is excluded from the table above as it is subject to ongoing negotiations with Ochoa. Once finalized, we expect to consummate the transaction as soon as practicable.

 

Reconciliations of Non-GAAP Financial Measures to Reported Amounts

 

To supplement the financial information included in this report, we have presented Adjusted EBITDA, Adjusted EBITDA including unconsolidated joint ventures and Adjusted Diluted EPS, each of which is considered a non-GAAP financial measure.

 

Lamb Weston’s management uses Adjusted EBITDA, Adjusted EBITDA including unconsolidated joint ventures and Adjusted Diluted EPS to evaluate the Company’s performance excluding the impact of certain non-cash charges and other special items in order to have comparable financial results to analyze changes in our underlying business between reporting periods. The Company includes these non-GAAP financial measures because management believes they are useful to investors in that they provide for greater transparency with respect to supplemental information used by management in its financial and operational decision making. We believe that the presentation of these non-GAAP financial measures, when used in conjunction with GAAP financial measures, is a useful financial analysis tool that can assist investors in assessing the Company’s operating performance and underlying prospects. These non-GAAP financial measures should be viewed in addition to, and not as alternatives for, financial measures prepared in accordance with GAAP. These non-GAAP financial measures may differ from similarly titled non-GAAP financial measures presented by other companies, and other companies may not define these non-GAAP financial measures the same way. These measures are not a substitute for their comparable GAAP financial measures, such as net income (loss) or diluted earnings per share, and there are limitations to using non‑GAAP financial measures.

 

The following table reconciles net income to Adjusted EBITDA and Adjusted EBITDA including unconsolidated joint ventures.

 

 

Fiscal 2017 includes a $3.1 million non-cash gain on assets.

 

Fiscal 2016 and 2014 include $59.5 million and $3.4 million, respectively, of charges reflecting Lamb Weston’s portion of actuarial losses in excess of 10% of Conagra’s pension liability for Conagra sponsored plans.

 

Fiscal 2016, 2015, and 2014 include $0.1 million, $0.7 million, and $2.1 million, respectively, related to costs incurred in connection with Conagra’s initiative to improve selling, general and administrative effectiveness and efficiencies, which is referred to as the Supply Chain and Administrative Efficiency Plan (“SCAE Plan”).