Lamb Weston Holdings, Inc. - Annual Report: 2019 (Form 10-K)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

☒       ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended May 26, 2019

OR

☐       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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 every Interactive Data File required to be submitted 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 such files).    Yes ☒    No ☐

 

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.

 

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 as of November 23, 2018 (the last trading day of the registrant's most recently completed second fiscal quarter) was approximately $11.9 billion based upon the closing sale price of the common stock as reported on the New York Stock Exchange on such date. As of July 15, 2019, the registrant had 146,069,033 shares of common stock, par value $1.00 per share, outstanding.

 

Documents Incorporated by Reference

 

 

 

 

 

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,” “continue,” “may,” “expect,” “anticipate,” “would,” “could,” “believe,” “estimate,” “grow,” “drive,” “invest,” “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, capital investments, dividends, share repurchases, business outlook and prospects, and remediation of the material weakness in internal control. 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 and our joint ventures operate; political and economic conditions of the countries in which we and our joint ventures conduct business and other factors related to our international operations; disruption of our access to export mechanisms; risks associated with possible acquisitions, including our ability to complete acquisitions or integrate acquired businesses; our debt levels; 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; our ability to remediate the material weakness in internal control; 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”). 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 governed the relationship between us and Conagra following the Separation and provided for the allocation of various assets, liabilities, rights and obligations of the parties. These agreements also included arrangements for transition services 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 14, 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. 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.

 

Following the Separation, our consolidated financial statements include the accounts of Lamb Weston Holdings, Inc. and its wholly owned subsidiaries.

 

Segments

 

We have four reportable segments: Global, Foodservice, Retail, and Other. For segment financial information see Note 15, 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:

 

 

 

On November 2, 2018, we entered into a Membership Interest Purchase Agreement (the “BSW Agreement”) with Ochoa Ag Unlimited Foods, Inc. (“Ochoa”) to acquire the remaining 50.01% interest in Lamb Weston BSW, LLC, a potato processing joint venture (“Lamb Weston BSW”). Prior to entering into the BSW Agreement, we were the primary beneficiary of Lamb Weston BSW, a variable interest entity, and accordingly, we consolidated the financial statements of Lamb Weston BSW and deducted 50.01% of the operating results of the noncontrolling interests to arrive at “Net income attributable to Lamb Weston Holdings, Inc.” on our Combined and Consolidated Statement of Earnings. Our Combined and Consolidated Statements of Earnings include 100% of Lamb Weston BSW’s earnings beginning November 2, 2018. For more information, see Note 7, 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 10% of our consolidated net sales in fiscal 2019 and 11% of our consolidated net sales in both fiscal 2018 and 2017. No other customer accounted for more than 10% of our fiscal 2019, 2018, or 2017 consolidated net sales. Accounts receivable from one customer accounted for 12% of our consolidated accounts receivable at May 27, 2018. No customer accounted for more than 10% of our consolidated accounts receivable as of May 26, 2019.

 

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 and improving food safety. Research

and development expenses were $15.4 million, $13.5 million, and $10.6 million in fiscal 2019, 2018, and 2017, respectively.

 

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 registrations are 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, 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, 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.

 

Raw Materials and Packaging

 

Our primary raw materials are potatoes, edible oils, 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 our products is grown in Washington, Idaho, and Oregon. For Lamb-Weston/Meijer, European growing regions for the necessary potatoes are concentrated in the Netherlands, Austria, Belgium, Germany, France, and the United Kingdom. We also have growing regions in China and Australia. 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 operate 17 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.

International Operations

 

At May 26, 2019, we had operations in twelve countries, with manufacturing and processing facilities in four countries. Foreign net sales, including sales by domestic segments to customers located outside of the United States, were approximately $742.7 million, $665.8 million, and $663.5 million in fiscal 2019, 2018, and 2017, respectively. Our long-lived assets located outside of the United States are not significant. See Note 15, 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.

 

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 North America, Europe and other international markets is highly competitive. Competitors include large North American and European frozen potato product companies that compete globally, as well as local and regional companies. Significant competitors include McCain Foods Limited, J.R. Simplot Company, Cavendish Farms Corporation, The Kraft Heinz Company, Clarebout Potatoes NV, Aviko B.V., Agristo NV, Farm Frites International B.V. and Mydibel S.A. 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, 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.

 

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, 2019, we had approximately 7,600 employees, excluding our joint ventures. Approximately 700 of these employees work outside of the United States. Approximately 32% 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 32% expire in fiscal 2020. As these agreements expire, we believe they will be renegotiated on terms satisfactory to us. 

Information About Our Executive Officers

 

The following are our executive officers as of July 15, 2019:

 

 

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 quick service 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. On April 18, 2019, Mr. Martin notified us of his decision to retire. Mr. Martin will remain in his current position until his successor is appointed to ensure a smooth transition.

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 of Foodservice, Retail, 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, including through our joint ventures. During each of fiscal 2019, 2018 and 2017, net sales outside the United States, primarily in Canada, 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 2019, 2018, and 2017, export sales from the United States accounted for approximately 16%, 17% and 19%, respectively, 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 facilities in Australia, Canada and China and a 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 26, 2019, we had $2,318.2 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 agreements governing our term loans 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. Further, under the terms of the tax matters agreement we entered into with Conagra at the Separation, we may not retire, repurchase, or significantly modify our senior notes during the five-year period following the spinoff.

 

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 Washington, Idaho, and Oregon. European growing regions for the necessary potatoes are concentrated in the Netherlands, Austria, Belgium, Germany, France, 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, such as the drought in Europe during our fiscal year 2019, 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 Australia, Austria, 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, such as the drought in Europe during our fiscal year 2019. 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 and other input 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. In addition, we also incur expenses in connection with the transportation and delivery of our products. Commodity price increases or constraints in the supply or availability of key commodities, including necessary services such as transportation and warehousing, may 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 functions. 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. Our largest customer, McDonald’s Corporation, accounted for approximately 10% of our consolidated net sales in fiscal 2019, and 11% of our consolidated net sales in both 2018 and 2017. 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 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. Despite careful security and controls design, implementation, updating and independent third-party verification, 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.

 

We intend to replace our information technology infrastructure, and plan to implement a new enterprise resource planning system. Problems with the transition, design, or implementation of this upgrade could interfere with our business and operations and adversely affect our financial condition.

 

We are currently in the process of replacing our information technology infrastructure with a new enterprise resource planning (“ERP”) system, which we expect to implement during fiscal 2021. We may experience difficulties as we transition to new upgraded systems and processes. These difficulties may include loss of data; difficulty in processing customer orders, shipping products, or providing services and support to our customers; difficulty in billing and tracking our orders; difficulty in completing financial reporting and filing reports with the SEC in a timely manner; or challenges in otherwise running our business. We may also experience decreases in productivity as our personnel implement and become familiar with new systems and processes. Any disruptions, delays, or deficiencies in the transition, design, and implementation of a new ERP system, particularly any disruptions, delays, or deficiencies that impact our operations, could have a material adverse effect on our business, financial condition, and results of operations. Even if we do not encounter adverse effects, the transition, design, and implementation of a new ERP system, may be much more costly than we anticipated.

 

We identified a material weakness in our internal control related to ineffective information technology general controls which, if not remediated appropriately or timely, could materially and adversely affect our business, financial condition and results of operations.

 

Internal controls related to the operation of technology systems are critical to maintaining adequate internal control over financial reporting. As disclosed in “Part II, Item 9A. Controls and Procedures” of this Form 10-K, when assessing the effectiveness of internal control over financial reporting as of May 26, 2019, management identified a material weakness in an internal control over the timely termination of temporary access to an information technology system that supports our financial reporting processes that was granted to certain authorized members of our application support team. As a result, we concluded that our internal control over financial reporting was not effective as of May 26, 2019. We are implementing remedial measures and, while there can be no assurance that our efforts will be successful, we plan to remediate the material weakness prior to the end of fiscal 2020. If we are unable to remediate the material weakness or are otherwise unable to maintain effective internal control over financial reporting or disclosure controls and procedures, our ability to record, process and report financial information accurately, and to prepare financial statements within required time periods, could be adversely affected. 

 

If we were unable to prepare our future financial statements in conformity with U.S. GAAP as required, such circumstances would expose us to potential events of default (if not cured or waived) under the financial and operating covenants contained in our various debt instruments and cause us to seek any necessary consents, waivers or amendments from our lenders. Under such circumstances, we would face the risk that we may not be able to obtain any such consents, waivers or amendments, that the terms of any such consents, waivers or amendments might be less favorable than the current terms of our indebtedness or we may not be able to refinance our existing indebtedness to enable us to repay that indebtedness when it becomes due. Also, if we were unable to prepare our future financial statements in conformity with U.S. GAAP as required, it could result in damage to our reputation or lead to regulatory proceedings or private litigation, any or all of which could result in additional business disruptions and the Company incurring potentially substantial costs, and our stock price could be adversely impacted.

 

Accordingly, if we are unable to remediate the material weakness in the future or are otherwise unable to maintain effective internal control over financial reporting or disclosure controls and procedures, such events could materially and adversely affect our business, financial condition and results of operations.

 

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, as noted in our material weakness described above. 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 26, 2019, we had goodwill of $205.9 million and other intangibles of $37.6 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 brands, trademarks, licensing agreements, 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:

 

 

 

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

ITEM 2. PROPERTIES

 

We are headquartered in Eagle, Idaho and at May 26, 2019, 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 15, 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, plants and distribution facilities in Canada, China, the Netherlands, the United Kingdom, Austria, Russia, and the United States. In July 2019, we acquired another frozen potato processor in Australia, with a leased plant that adds approximately 70 million pounds of production capacity to our manufacturing network.

 

 

ITEM 3. LEGAL PROCEEDINGS

 

For information regarding our legal proceedings, see Note 16, 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

 

Not applicable.

 

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 15, 2019, there were 12,863 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.

 

Purchases of Equity Securities by the Issuer

 

The following table presents information related to repurchases of our common stock during the periods presented below (dollars in millions, except per share data):

 

 

Performance Graph

 

The following graph and table compare the cumulative total return on our common stock with the cumulative total return of the Standard & Poor’s (“S&P”) 500 Index, S&P 400 Midcap Index, and the S&P Packaged Food Index, which we consider to be our peer group. This graph and table cover the period from November 10, 2016 (the first day our common stock began trading on NYSE) through May 24, 2019 (the last trading day of our fiscal year). The graph and table assume that $100 was invested in our common stock, the S&P 500 Index, the S&P 400 Midcap Index, and the S&P Packaged Food Index on November 10, 2016, and that all dividends were reinvested.  The cumulative total return shown below are based on the last trading day in Lamb Weston’s fiscal year.

 

 

 

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, as amended.

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.

 

 

In fiscal 2018, the Tax Act decreased income tax expense and increased net income by $64.7 million, or $0.44, including a $36.3 million, or $0.25 per share, tax benefit related to a lower U.S. corporate tax rate and a provisional $28.4 million, or $0.19 per share, benefit from the re-measurement of our net U.S. deferred tax liabilities using the new U.S. statutory tax rate, partially offset by a transition tax on previously untaxed foreign earnings.

 

 

 

 

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 26, 2019 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. The fiscal 2017 combined financial statements included in this Form 10-K were prepared on a stand-alone basis and were derived from Conagra’s consolidated financial statements and accounting records and reflect our 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 fiscal 2017 financial information that includes periods prior to the Separation may not be indicative of what our results of operations and cash flows would have been as a separate stand-alone public company during all of fiscal 2017, nor are they indicative of what our 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 delivered strong financial results in fiscal 2019, reflecting the favorable operating environment and our focus on delivering our strategic and operational objectives. Specifically, in fiscal 2019, compared with fiscal 2018:

 

 

Demand for frozen potato products continues to grow around the world. We expect to address the increase in demand by investing in additional capacity. We began operating a new processing line in Boardman, Oregon during the third quarter of fiscal 2017 as well as a new line in Richland, Washington during the second quarter of fiscal 2018. In addition, our new line in Hermiston, Oregon with a total annual production capacity of approximately 300 million pounds, became operational in May 2019. During the third quarter of fiscal 2019, we purchased the remaining interest in our Lamb Weston BSW joint venture, and acquired a frozen potato processor in Australia, which added approximately 50 million pounds of production capacity to our manufacturing network. In July 2019, we acquired another frozen potato processor in Australia, which added approximately 70 million pounds of production capacity to our manufacturing network. Lamb-Weston/Meijer, our joint venture in Europe, recently expanded capacity at its facility at Bergen op Zoom, the Netherlands, and in June 2017, acquired the potato processing business of Oerlemans Foods, which included a potato processing facility located in Broekhuizenvorst, the Netherlands. Lamb-Weston/Meijer is also party to a joint venture that constructed a new production facility in Lipetsk, a special economic zone in south Moscow, the Russian Federation, which began operations in the third quarter of fiscal 2018.

 

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 2019. In North America, volume demand growth was driven by quick service restaurant chains (“QSRs”), as well as in retail channels. Outside North America, demand growth was driven by increased access to consumers through continued expansion in these markets by both North America-based QSRs, local QSRs, and other chain and independent restaurants. In emerging markets, demand growth was also 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 in North America to produce frozen potato products in fiscal 2019, which led to increased raw potato costs across the industry. In Europe, a poor potato crop resulted in higher manufacturing costs.

 

Outlook 

 

In fiscal 2020, we expect the overall operating environment will be generally favorable with continued solid demand growth in North America and our key international markets. New industry capacity in North America and Europe may ease near-term capacity constraints and will allow processors to operate their production facilities at more normalized levels. In addition, we expect the rate of inflation for many of our commodity and manufacturing costs will be similar to fiscal 2019. We also expect higher selling, general and administrative costs as a result of investments in our enterprise resource planning infrastructure, as well as for continued improvements in our information systems, 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 15, 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 26, 2019 Compared to Fiscal Year Ended May 27, 2018

 

Net Sales and Product Contribution Margin (dollars in millions)

 

 

Net Sales

 

Lamb Weston’s net sales for fiscal 2019 increased $332.8 million, or 10%, to $3,756.5 million, compared with $3,423.7 million in fiscal 2018. Net sales in fiscal 2019 reflect a 5% increase in volume and 5% increase in price/mix, primarily driven by growth in our Global segment.

 

Global net sales increased $217.3 million, or 12%, to $1,961.5 million, compared with $1,744.2 million in fiscal 2018. Net sales in fiscal 2019 reflect a 7% increase in sales volumes, driven by growth in sales to strategic customers in the U.S. and key international markets, as well as the benefit of limited time product offerings. Price/mix increased 5%, largely reflecting pricing actions and favorable customer mix.

 

Foodservice net sales increased $57.0 million, or 5%, to $1,156.1 million, compared with $1,099.1 million in fiscal 2018. Net sales in fiscal 2019 reflect a 5% increase primarily reflecting pricing actions initiated in the fall of 2018, as well as improved mix. Sales volume declined nominally, as the loss of some distributor and operator-label product volumes essentially offset growth in branded products.

 

Retail net sales increased $49.1 million, or 11%, to $498.3 million, compared with $449.2 million in fiscal 2018. Net sales in fiscal 2019 reflect a 7% increase in sales volume, primarily driven by distribution gains of Grown in Idaho and other branded products. Price/mix increased 4%, largely due to improved mix and pricing actions.

 

Net sales in our Other segment increased $9.4 million, or 7%, to $140.6 million, compared with $131.2 million in fiscal 2018. The increase primarily reflects higher price/mix in our vegetable business.

 

Product Contribution Margin

 

Lamb Weston’s product contribution margin for fiscal 2019 increased $123.2 million, or 15%, to $971.1 million, compared with $847.9 million in fiscal 2018.

 

Global product contribution margin increased $70.6 million, or 19%, to $446.3 million in fiscal 2019, as a result of favorable price/mix, volume and supply chain efficiency savings which more than offset input, manufacturing and transportation cost inflation, as well as higher depreciation expense primarily associated with the new production line in Richland, Washington. Global cost of sales was $1,508.4 million, or 11% higher in fiscal 2019, as compared to fiscal 2018, largely due to higher sales volume, cost inflation, and higher depreciation expense, partially offset by supply chain efficiency savings. Advertising and promotion spending was modestly higher in 2019, as compared to fiscal 2018.

 

Foodservice product contribution margin increased $36.5 million, or 10%, to $402.4 million in fiscal 2019, primarily as a result of favorable price/mix and supply chain efficiency savings, which more than offset input, manufacturing and transportation cost inflation, as well as higher depreciation expense primarily associated with the new Richland production line. Cost of sales was $746.0 million, or 3% higher in fiscal 2019, as compared to fiscal 2018, largely

due to cost inflation and higher depreciation expense, partially offset by supply chain efficiency savings. Advertising and promotion spending declined approximately $1 million in fiscal 2019, compared with fiscal 2018.

 

Retail product contribution margin increased $11.5 million, or 13%, to $98.8 million in fiscal 2019 due to volume growth and favorable price/mix, more than offsetting input, manufacturing and transportation cost inflation. Cost of sales was $381.9 million, or 10% higher in fiscal 2019 as compared to fiscal 2018, largely due to higher sales volume and cost inflation. Advertising and promotion spending was $1.6 million higher in fiscal 2019, compared with fiscal 2018, primarily in support of Grown in Idaho and other branded products.

 

Other product contribution margin increased $4.6 million to $23.6 million in fiscal 2019, as compared to $19.0 million in fiscal 2018. These amounts include a $3.3 million loss related to unrealized mark-to-market adjustments and realized settlements associated with commodity hedging contracts in fiscal 2019, and a $1.1 million gain related to the contracts in fiscal 2018. Excluding these adjustments, Other segment product contribution margin increased $9.0 million, largely due to improved price/mix in our vegetable business.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative (“SG&A”) expenses increased $35.7 million, or 12%, in fiscal 2019 compared with fiscal 2018. Fiscal 2018 included $8.7 million ($5.7 million after-tax) for costs related to the Separation, primarily related to professional fees and other employee-related costs.

 

Excluding the Separation costs, fiscal 2019 SG&A expenses increased $44.4 million, or 15%, versus the prior year. The increase in SG&A expenses, excluding comparability items, was largely driven by higher expenses related to information technology services and infrastructure, as well as investments in our sales, marketing and operating capabilities. The increase was also driven by approximately $8 million of unfavorable foreign exchange (reflecting an approximate $3 million expense in fiscal 2019 compared to an approximate $5 million benefit in fiscal 2018), an approximate $2 million increase in incentive compensation expense that primarily reflected an increase in stock price and absolute shares outstanding, and an approximate $1 million increase in advertising and promotional support, partially offset by an approximate $4 million benefit from an insurance settlement. 

 

Interest Expense, Net

 

Interest expense, net was $107.1 million in fiscal 2019, a decrease of $1.7 million compared with fiscal 2018. The decrease in interest expense, net was the result of lower average total debt versus the prior year.

 

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 in both fiscal 2019 and 2018 was impacted by the Tax Act enacted in December 2017. Notably, the Tax Act reduced the U.S. statutory tax rate from 35% to 21%, assessed a one-time transition tax on earnings of non-U.S. subsidiaries that have not been taxed previously in the U.S., limited the tax deductibility of interest, provided for immediate deductions for certain new investments instead of deductions for depreciation expense over time, modified or repealed many business deductions and credits, and created new taxes on certain future foreign-sourced earnings.

A reconciliation of income tax expense, including the impact of the comparability items recorded in fiscal 2019 and 2018, related to the Tax Act, is as follows (in millions):

 

 

 

For further information on the Tax Act and its impact, see Note 5, 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 $59.5 million and $83.6 million for fiscal 2019 and 2018, respectively. These amounts included a $2.6 million unrealized loss related to mark-to-market adjustments associated with currency and commodity hedging contracts in fiscal 2019, and a nominal unrealized loss related to the contracts in fiscal 2018. Excluding these adjustments, earnings from equity method investments declined $21.6 million, compared to fiscal 2018, largely reflecting higher raw potato prices and lower sales volumes associated with a poor crop in Europe. For more information about our joint ventures, see Note 7, 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.

 

Acquisition of Remaining 50.01% Interest in Lamb Weston BSW

 

On November 2, 2018, we entered into a Membership Interest Purchase Agreement (the “BSW Agreement”) with Ochoa Ag Unlimited Foods, Inc. (“Ochoa”) to acquire the remaining 50.01% interest in Lamb Weston BSW, a potato processing joint venture. We paid Ochoa approximately $65 million in cash attributable to our contractual right to purchase the remaining equity interest in Lamb Weston BSW, plus $13.2 million attributable to Ochoa’s interest in expected earnings of the joint venture through our fiscal year ended May 26, 2019.

 

Prior to entering into the BSW Agreement, Lamb Weston BSW was considered a variable interest entity, and we determined that we were the primary beneficiary of the entity. Accordingly, we consolidated the financial statements of Lamb Weston BSW and deducted 50.01% of the operating results of the noncontrolling interests to arrive at “Net income

attributable to Lamb Weston Holdings, Inc.” on our Combined and Consolidated Statements of Earnings. The Combined and Consolidated Statements of Earnings include 100% of Lamb Weston BSW’s earnings beginning November 2, 2018, the date we entered into the BSW Agreement.

 

Prior to entering into the BSW Agreement, the value of the redeemable noncontrolling interest was recorded on our Consolidated Balance Sheet based on the value of Ochoa’s put option. In connection with the purchase of the remaining 50.01% interest in the joint venture, we recorded $9.4 million of accretion, net of tax benefits, to increase the redeemable noncontrolling interest to the amount we agreed to pay. The purchase created $9.3 million of deferred tax assets related to the step-up in tax basis of the acquired assets. We recorded both the accretion of the noncontrolling interest and the related tax benefits in “Additional distributed capital” on our Consolidated Balance Sheet and they did not impact net income. While the accretion, net of tax benefits, had no impact on net income in the Combined and Consolidated Statements of Earnings, it reduced net income available to common stockholders $9.4 million, net of tax benefits, and both basic and diluted earnings per share $0.06, during fiscal 2019.

 

Acquisition

 

In December 2018, we acquired a frozen potato processor in Australia for $88.6 million, net of cash acquired. We allocated the purchase price to the assets acquired and liabilities assumed based on estimates of the fair value at the date of acquisition, of which $75.1 million was allocated to goodwill. Operating results of the acquired company subsequent to December 21, 2018 have been included in our Global segment.

 

 

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 increased $255.7 million, or 8%, to $3,423.7 million, compared with $3,168.0 million for 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

 

SG&A 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, SG&A 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 SG&A expenses also included 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

 

 

In connection with our initial analysis of the impact of the Tax Act in fiscal 2018, income tax expense decreased $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 5, 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 7, 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 2019, cash from operations increased $199.7 million to $680.9 million. In addition to using cash for normal operating requirements, we invested in our business and returned cash to shareholders. In fiscal 2019, we spent $334.2 million on capital expenditures, including the construction of a new french fry line in Hermiston, Oregon, that

added 300 million pounds of additional annualized production capacity. We also used cash for acquisitions. We expanded our global footprint with the acquisition of a frozen potato processor in Australia for $88.6 million, net of cash acquired, and we purchased the remaining interest in our Lamb Weston BSW joint venture for $78.2 million. Finally, we returned cash to shareholders, including $113.3 million in dividends and we repurchased 458,749 shares of our common stock for $31.8 million. We ended the year with $12.2 million of cash and cash equivalents and $489.4 million of available borrowing capacity on our revolving credit facility. Currently, our primary uses of cash are for operations, capital expenditures, dividends on our common stock, acquisitions, debt service, income tax payments, and stock repurchases. 

 

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 declared on our common stock, 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 2019 Compared with Fiscal 2018

 

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 $199.7 million to $680.9 million in fiscal 2019, compared with $481.2 million in fiscal 2018. Earnings from continuing operations, adjusted for non-cash income and expense and other items, increased $161.5 million primarily due to favorable price/mix and sales volumes, and a decrease in cash taxes. Changes in operating assets and liabilities provided $38.2 million more cash in fiscal 2019, compared with fiscal 2018. The increase in cash provided by changes in operating assets and liabilities was driven primarily by the timing of payments for accounts payable, timing of receipt of cash for accounts receivable, a smaller year-over-year increase in prepaid expenses and current assets, and inventories. These changes were offset partially by the timing of payments for income taxes and accrued expenses.

 

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.

 

Investing Activities

 

Fiscal 2019 Compared with Fiscal 2018

 

Investing activities used $423.0 million of cash in fiscal 2019, compared with $306.8 million in fiscal 2018. These expenditures include the plant capacity expansions in Hermiston, Oregon in fiscal 2019 and Richland, Washington in fiscal 2018. Additionally, in December 2018, we acquired 100% of the outstanding shares of a frozen potato processor in Australia for $88.6 million, net of cash acquired.

 

We expect capital investments in fiscal 2020 to be approximately $275 million, which excludes acquisitions. 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 26, 2019, we had commitments for capital expenditures of $41.5 million.

 

In July 2019, we acquired another frozen potato processor in Australia, for approximately $117 million, plus or minus final working capital adjustments. This added approximately 70 million pounds of production capacity to our manufacturing network.

 

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 facility in fiscal 2018 and Boardman, Oregon facility in fiscal 2017.

 

Financing Activities

 

Fiscal 2019 Compared with Fiscal 2018

 

During fiscal 2019, cash used for financing activities totaled $299.6 million, compared with cash used for financing activities of $178.9 million in fiscal 2018. During fiscal 2019, financing activities primarily related to the payment of $113.3 million in dividends on our common stock, $78.2 million to acquire the noncontrolling interest in Lamb Weston BSW, $66.7 million of debt payments, primarily scheduled payments under our term loan facility and the repayment of the Lamb Weston BSW installment notes, and $6.1 million of distributions paid to noncontrolling interest. Financing activities during 2019 also included the repurchase of 522,260 shares of our common stock, including restricted stock tax withholdings. Repurchases of common stock and payments of restricted stock withholding taxes totaled $36.4 million, including $31.8 million related to shares repurchased at an average price of $69.40 per share under our share repurchase program. In December 2018, we announced an authorization to repurchase up to $250.0 million of our common stock. We will continue to repurchase shares, on an opportunistic basis, in open market repurchase transactions. As of July 15, 2019, $218.2 million remained authorized for purchase under the program.

 

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.

 

On June 28, 2019, we amended our credit agreement to refinance $300.0 million of the $599.1 million term loan facility outstanding at May 26, 2019 (“New Term Loan Agreement”), for a lower overall interest rate, including anticipated patronage dividends. The New Term Loan Agreement bears interest, before anticipated patronage dividends, at LIBOR or

the Base Rate (each as defined in the New Term Loan Agreement) plus an applicable margin ranging from 1.625% to 2.375% for LIBOR-based loans and from 0.625% to 1.375% for Base Rate-based loans, depending upon our total net leverage ratio. The borrowings under the New Term Loan Agreement mature June 28, 2024, and the covenants, events of default, and guarantees are consistent with the Credit Facilities discussed in 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. The amended credit agreement also provides for the ability, under certain circumstances, to add incremental facilities in an aggregate amount of up to $100.0 million. Our total term loan indebtedness remains the same before and after the refinancing. 

 

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 26, 2019, we were in compliance with the financial covenant ratios and other covenants contained in our credit agreement.

 

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.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements as of May 26, 2019 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 7, 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 26, 2019, are 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.