CONAGRA BRANDS, INC. 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 consolidated financial
statements and related notes in Item 8, Financial Statements and Supplementary
Data. Results for the fiscal year ended
FORWARD-LOOKING STATEMENTS
The information contained in this report includes forward-looking statements within the meaning of the federal securities laws. Examples of forward-looking statements include statements regarding our expected future financial performance or position, results of operations, business strategy, plans and objectives of management for future operations, and other statements that are not historical facts. You can identify forward-looking statements by their use of forward-looking words, such as "may", "will", "anticipate", "expect", "believe", "estimate", "intend", "plan", "should", "seek", or comparable terms.
Readers of this report should understand that these forward-looking statements
are not guarantees of performance or results. Forward-looking statements provide
our current expectations and beliefs concerning future events and are subject to
risks, uncertainties, and factors relating to our business and operations, all
of which are difficult to predict and could cause our actual results to differ
materially from the expectations expressed in or implied by such forward-looking
statements. These risks, uncertainties, and factors include, among other
things: the risk that the cost savings and any other synergies from the
acquisition of
The discussion that follows should be read together with the consolidated financial statements and related notes contained in this report. Results for fiscal 2022 are not necessarily indicative of results that may be attained in the future.
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Table of Contents EXECUTIVE OVERVIEW
Fiscal 2022 Results
Fiscal 2022 performance compared to fiscal 2021 reflected an increase in net sales, with organic (excludes the impacts of foreign exchange and divested businesses) increases in all of our operating segments. Overall gross profit decreased primarily as a result of input cost inflation, higher transportation costs, elevated supply chain operating costs due, in part, to disruptions in the availability of labor and certain materials, and lost profits from divested businesses, which were partially offset by higher organic net sales, supply chain realized productivity, cost synergies associated with the Pinnacle acquisition, and lower COVID-19 pandemic-related expenses. Overall segment operating profit decreased in all of our operating segments. Corporate expenses were lower primarily due to items impacting comparability, as discussed below, in addition to lower share-based payment and deferred compensation expense. Selling, general and administrative ("SG&A") expenses were higher primarily due to items impacting comparability, partially offset by lower advertising and promotional expenses. We recognized higher equity method investment earnings, lower interest expense, higher income tax expense, in each case compared to fiscal 2021. Excluding items impacting comparability, our effective tax rate was slightly higher compared to fiscal 2021.
Diluted earnings per share in fiscal 2022 were
During fiscal 2022, we experienced higher than expected input cost inflation, including higher transportation and supply chain costs, that negatively impacted gross margins. We expect input cost inflation to persist in fiscal 2023. Supply chain realized productivity and pricing actions will mitigate some of the inflationary pressures and are expected to improve margins more heavily in the third and fourth quarters of fiscal 2023. As our estimates of inflation for fiscal 2023 continue to change, it is impractical to quantify the impact at this time.
Although we are a North American focused company with no operations in or direct
exposure to
Items Impacting Comparability
Items of note impacting comparability of results for continuing operations for fiscal 2022 included the following:
• charges totaling$209.0 million ($159.0 million after-tax and net of noncontrolling interest) related to the impairment of certain brand intangible assets, • charges totaling$70.1 million ($60.4 million after-tax) related to the impairment of businesses held for sale, • charges totaling$49.0 million ($36.9 million after-tax) in connection with our restructuring plans, • tax expense of$25.0 million related to certain tax elections made in connection with filing our fiscal 2021 tax return, for which any associated tax benefits are still under review with theIRS , • an income tax benefit of$16.1 million related to the settlement of certain tax matters that were previously reserved and a release of valuation allowance on certain foreign tax credit carryforwards, • a gain of$19.6 million ($14.8 million after-tax) related to two favorable legal settlements, • charges of$11.3 million ($8.5 million after-tax) associated with fires occurring at two of our manufacturing facilities, 23
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Table of Contents • a gain of$6.5 million ($5.0 million after-tax) related to a settlement of a legacy environmental matter, and • a gain of$3.3 million ($2.8 million after-tax) related to proceeds received from the sale of a legacy investment.
Items of note impacting comparability of results from continuing operations for fiscal 2021 included the following:
• a non-cash income tax benefit of$115.6 million associated with a restructuring of our ownership interest in the Ardent Mills joint venture, which primarily relates to a release of a valuation allowance due to the generation of capital gains, • charges totaling$90.9 million ($69.9 million after-tax) related to the impairment of certain brand intangible assets, • charges totaling$77.9 million ($58.3 million after-tax) in connection with our restructuring plans, • charges totaling$68.7 million ($51.5 million after-tax) related to the early extinguishment of debt, • a gain of$65.5 million ($34.5 million after-tax) associated with the divestiture of certain businesses, • an income tax benefit of$37.0 million related to a release of valuation allowance associated with the divestiture of certain businesses, • an income tax benefit of$7.6 million related to certain final tax regulations on prior year federal tax matters, • consulting expenses totaling$7.2 million ($5.4 million after-tax) primarily associated with securing tax benefits for a new production facility (the associated tax benefits will be recognized in future periods), • a loss of$7.1 million ($5.3 million after-tax) related to the early exit of an unfavorable contract associated with a recent divestiture, and • charges totaling$5.7 million ($4.3 million after-tax) associated with costs incurred for acquisitions and divestitures.
Segment presentation of gains and losses from derivatives used for economic hedging of anticipated commodity input costs and economic hedging of foreign currency exchange rate risks of anticipated transactions are discussed in the segment review below.
Divestitures
During the fourth quarter of fiscal 2021, we completed the sale of our Egg
Beaters® business for net proceeds of
During the third quarter of fiscal 2021, we completed the sale of our Peter Pan®
peanut butter business for net proceeds of
During the third quarter of fiscal 2020, we completed the sale of our Lender's®
bagel business for net proceeds of
During the second quarter of fiscal 2020, we completed the sale of our Direct
Store Delivery ("DSD") snacks business, for net proceeds of
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Table of Contents Restructuring Plans
In
In fiscal 2019, senior management initiated a restructuring plan for costs
incurred in connection with actions taken to improve SG&A expense effectiveness
and efficiencies and to optimize our supply chain network (the "Conagra
Restructuring Plan"). Although we remain unable to make good faith estimates
relating to the entire Conagra Restructuring Plan, we are reporting on actions
initiated through the end of fiscal 2022, including the estimated amounts or
range of amounts for each major type of cost expected to be incurred, and the
charges that have resulted or will result in cash outflows. As of
COVID-19 Pandemic
We continue to monitor the impact of the COVID-19 pandemic on all aspects of our
business. Throughout fiscal 2022, we continued to experience elevated demand for
our products in the retail segments versus pre-pandemic levels, but volumes were
lower compared to fiscal 2021, primarily due to the elasticity impact from
inflation-driven pricing actions. We experienced higher demand for our
foodservice products across all of our major markets during fiscal 2022 compared
to fiscal 2021 as consumer traffic in away-from-home food outlets continue to
recover from the impacts of the pandemic. We incurred
As we continue into fiscal 2023, we generally expect retail demand levels to remain elevated versus pre-pandemic levels and we continue to expect foodservice demand levels to return to more historical norms. However, uncertainty remains with the pandemic and such trends ultimately depend on the length and severity of the pandemic, inclusive of the introduction of new strains and variants of the virus; infection rates in the markets where we do business; the federal, state, and local government actions taken in response; vaccine effectiveness; and the macroeconomic environment. In fiscal 2023, we continue to expect to see inflationary headwinds but anticipate that gross margins will begin to benefit from sales price increases and other cost savings measures. We also continue to expect a decrease in costs related to the COVID-19 pandemic and a decrease in supply chain costs as we focus on realized productivity initiatives. We will continue to evaluate the extent to which the COVID-19 pandemic will impact our business, consolidated results of operations, and financial condition.
We have experienced some challenges in connection with the COVID-19 pandemic, including with respect to the supply of our ingredients, packaging, or other sourced materials. Despite these challenges, all of our production facilities remain open. We cannot predict the ultimate COVID-19 impact on our suppliers, distributors, and manufacturers.
SEGMENT REVIEW
We reflect our results of operations in four reporting segments: Grocery & Snacks, Refrigerated & Frozen, International, and Foodservice.
Grocery & Snacks
The Grocery & Snacks reporting segment principally includes branded,
shelf-stable food products sold in various retail channels in
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Table of Contents Refrigerated & Frozen
The Refrigerated & Frozen reporting segment principally includes branded,
temperature-controlled food products sold in various retail channels in
International
The International reporting segment principally includes branded food products,
in various temperature states, sold in various retail and foodservice channels
outside of
Foodservice
The Foodservice reporting segment includes branded and customized food products,
including meals, entrees, sauces, and a variety of custom-manufactured culinary
products that are packaged for sale to restaurants and other foodservice
establishments primarily in
Presentation of Derivative Gains (Losses) from Economic Hedges of Forecasted Cash Flows in Segment Results
Derivatives used to manage commodity price risk and foreign currency risk are not designated for hedge accounting treatment. We believe these derivatives provide economic hedges of certain forecasted transactions. As such, these derivatives are generally recognized at fair market value with realized and unrealized gains and losses recognized in general corporate expenses. The gains and losses are subsequently recognized in the operating results of the reporting segments in the period in which the underlying transaction being economically hedged is included in earnings. In the event that management determines a particular derivative entered into as an economic hedge of a forecasted commodity purchase has ceased to function as an economic hedge, we cease recognizing further gains and losses on such derivatives in corporate expense and begin recognizing such gains and losses within segment operating results, immediately. See Note 19 "Business Segments and Related Information", to the Consolidated Financial Statements contained in this report for further discussion.
Presentation of Information
Below is a detailed discussion and comparison of our results of operations for
the fiscal years ended
Fiscal 2022 compared to Fiscal 2021
Net Sales ($ in millions) Fiscal 2022 Fiscal 2021 % Inc Reporting Segment Net Sales Net Sales (Dec) Grocery & Snacks$ 4,697.4 $ 4,624.7 2 % Refrigerated & Frozen 4,859.3 4,774.6 2 % International 970.8 938.6 3 % Foodservice 1,008.4 846.8 19 % Total$ 11,535.9 $ 11,184.7 3 %
Net sales for fiscal 2022 in our Grocery & Snacks segment included a decrease in
volumes of 4%, excluding the impact of divestitures, compared to the prior-year
period. This result was primarily due to lapping the prior year's surge in
at-home food consumption from the COVID-19 pandemic and replenishment of
customer inventory levels in connection with the COVID-19 pandemic coupled with
the elasticity impact from inflation-driven pricing actions. Price/mix
increased 7%, excluding the impact of divestitures, compared to the prior-year
period due to favorability in inflation-driven pricing coupled with favorable
brand mix, partially offset by a benefit in the prior-year period of
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Net sales for fiscal 2022 in our Refrigerated & Frozen segment included
a decrease in volumes of 5%, excluding the impact of divestitures, compared to
fiscal 2021. The decrease in sales volumes was primarily due to lapping the
prior year's surge in at-home food consumption from the COVID-19 pandemic and
replenishment of inventory levels in connection with the COVID-19 pandemic
coupled with the elasticity impact from inflation-driven pricing actions and
supply constraints. Price/mix increased 8% for fiscal 2022, excluding the impact
of divestitures, compared to fiscal 2021 primarily driven by favorability in
inflation-driven pricing coupled with favorable brand mix, partially offset by a
benefit in the prior-year period of
Net sales for fiscal 2022 in our International segment reflected
a 5% decrease in volumes, a 2% increase due to favorable foreign exchange rates,
and a 7% increase in price/mix, excluding the impact of divestitures, in each
case compared to fiscal 2021. The decrease in volumes was driven by lapping the
prior year's surge in at-home food demand from the COVID-19 pandemic coupled
with the elasticity impact from inflation-driven pricing actions. The increase
in price/mix was primarily due to favorability in inflation-driven pricing and
favorable product mix, partially offset by a benefit in the prior-year period of
Net sales for fiscal 2022 in our Foodservice segment included an increase in
volumes of 11%, excluding the impact of divestitures, compared to the prior-year
period. The increase in volume reflected the continued recovery of
away-from-home food outlets from the impacts of the COVID-19 pandemic, partially
offset by the elasticity impact from inflation-driven pricing actions.
Price/mix, excluding the impact of divestitures, increased 8% in fiscal 2022
compared to fiscal 2021, reflecting inflation-driven pricing and favorable
product mix. Fiscal 2021 included
SG&A Expenses (Includes general corporate expenses)
SG&A expenses totaled
Items impacting comparability of earnings
• charges totaling$209.0 million related to the impairment of certain brand intangible assets, • charges totaling$70.1 million related to the impairment of businesses held for sale, • net charges of$27.2 million in connection with our restructuring plans, • a gain of$19.6 million related to two favorable legal settlements, • a gain of$6.5 million related to a settlement of a legacy environmental matter, • a gain of$3.3 million related to the sale of a legacy investment, • charges of$2.8 million associated with consulting fees for certain tax matters, • charges of$2.4 million associated with costs incurred for planned divestitures, and • charges of$2.2 million associated with fires occurring at two of our manufacturing facilities.
Other changes in expenses compared to fiscal 2021
• a decrease in share-based payment and deferred compensation expense of$58.0 million , due to market declines, a reduction of estimated level of achievement of certain performance targets, and a decrease in our share price, • an increase in salary, wage, and fringe benefit expense of$19.8 million , • a decrease in advertising and promotion expense of$13.4 million driven by lapping increased investment in the prior year period, 27
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Table of Contents • a decrease in incentive compensation expense of$13.1 million , due to exceeding certain performance targets in the prior year period, • an increase of$10.6 million in foreign currency transaction gains/losses, primarily due to prior year gains on remeasuring certain intercompany notes payable, • an increase of$10.2 million in self-insurance expense due to favorable claim development in the prior year, • a decrease in consulting and professional fees of$8.2 million , • an increase in information technology-related expenses of$8.0 million , • a decrease of$5.9 million in commission expense due to our transition away from certain third-party brokers, and • an increase in travel and entertainment expense of$5.7 million .
SG&A expenses for fiscal 2021 included the following items impacting the comparability of earnings:
• charges of$90.9 million related to the impairment of certain brand intangible assets, • charges of$68.7 million associated with the early extinguishment of debt, • gains totaling$65.5 million related to divestitures of certain businesses, • net charges of$40.8 million in connection with our restructuring plans, • consulting expenses of$7.2 million primarily associated with securing tax benefits for a new production facility (the associated tax benefits will be recognized in future periods), • a loss of$7.1 million related to the early exit of an unfavorable contract associated with a recent divestiture, • charges of$5.7 million associated with costs incurred for acquisitions and divestitures, and • a net expense of$2.6 million related to a previous legal matter.
Segment Operating Profit (Earnings before general corporate expenses, pension and postretirement non-service income, interest expense, net, income taxes, and equity method investment earnings)
($ in millions) Fiscal 2022 Fiscal 2021 % Inc
Reporting Segment Operating Profit Operating Profit (Dec)
Grocery & Snacks $ 859.5 $ 1,092.7 (21 )%
Refrigerated & Frozen 561.1 836.5 (33 )%
International 106.7 131.8 (19 )%
Foodservice 60.3 80.0 (25 )%
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Operating profit in our Grocery & Snacks segment for fiscal 2022 reflected
a decrease in gross profits of
Operating profit in our Refrigerated & Frozen segment for fiscal 2022 reflected
a decrease in gross profits of
Operating profit in our International segment for fiscal 2022 reflected flat
gross profits compared to fiscal 2021, reflecting the net sales growth discussed
above and the benefits of supply chain realized productivity, partially offset
by the impacts of input cost inflation. Operating profit of the International
segment was impacted by charges of
Operating profit in our Foodservice segment for fiscal 2022 reflected a decrease
in gross profits of
Pension and Postretirement Non-service Income
In fiscal 2022, pension and postretirement non-service income was
Interest Expense, Net
In fiscal 2022, net interest expense was
Income Taxes
Our income tax expense was
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In fiscal 2021, we completed a restructuring of our ownership interest in the Ardent Mills joint venture, a milling business ("Ardent Mills"), that utilized a portion of our capital loss carryforward prior to its expiration. After the restructuring, certain balance sheet adjustments on Ardent Mills may impact our effective tax rate in future periods. Also in fiscal 2021, we completed several other transactions related to retained assets in conjunction with the divestitures of the Peter Pan® peanut butter and Egg Beaters® businesses that we believe will utilize a portion of the remaining capital loss carryforward. These transactions were subject to elections made in connection with filing our fiscal 2021 federal tax return. These elections are still under review by the Internal Revenue Service. These elections may result in increases to the tax basis in those assets and if successful would result in tax benefits being realized in future periods.
We expect our effective tax rate in fiscal 2023, exclusive of any unusual transactions or tax events, to be approximately 24%.
Equity Method Investment Earnings
We include our share of the earnings of certain affiliates based on our economic
ownership interest in the affiliates. Our most significant affiliate is the
Ardent Mills joint venture. Our share of earnings from our equity method
investment earnings were
Earnings Per Share
Diluted earnings per share in fiscal 2022 and 2021 were
LIQUIDITY AND CAPITAL RESOURCES
Sources of Liquidity and Capital
The primary objective of our financing strategy is to maintain a prudent capital structure that provides us flexibility to pursue our growth objectives. We use a combination of equity and short- and long-term debt. We use short-term debt principally to finance ongoing operations, including our seasonal requirements for working capital (accounts receivable, prepaid expenses and other current assets, and inventories, less accounts payable, accrued payroll, and other accrued liabilities). We are committed to maintaining solid investment grade credit ratings.
Management believes that existing cash balances, cash flows from operations, existing credit facilities, our commercial paper program, and access to capital markets will provide sufficient liquidity to meet our debt obligations, including any repayment of debt or refinancing of debt, working capital needs, planned capital expenditures, other contractual obligations, and payment of anticipated quarterly dividends for at least the next twelve months.
Borrowing Facilities and Long-Term Debt
At
We had
During the first quarter of fiscal 2022, we issued
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Additional information about our long-term debt balances as of
We expect to maintain or have access to sufficient liquidity to retire or refinance long-term debt at maturity or otherwise, from operating cash flows, our commercial paper program, access to the capital markets, and our Revolving Credit Facility. We continuously evaluate opportunities to refinance our debt; however, any refinancing is subject to market conditions and other factors, including financing options that may be available to us from time to time, and there can be no assurance that we will be able to successfully refinance any debt on commercially acceptable terms at all.
As of the end of fiscal 2022, our senior long-term debt ratings were all investment grade. A significant downgrade in our credit ratings would not affect our ability to borrow amounts under the Revolving Credit Facility, although borrowing costs would increase. A downgrade of our short-term credit ratings would impact our ability to borrow under our commercial paper program by negatively impacting borrowing costs and causing shorter durations, as well as making access to commercial paper more difficult, or impossible.
Our most restrictive debt agreement (the Revolving Credit Facility) generally
requires our ratio of EBITDA to interest expense not be less than 3.0 to 1.0 and
our ratio of funded debt to EBITDA not to exceed 4.5 to 1.0. Each ratio is to be
calculated on a rolling four-quarter basis. As of
Equity and Dividends
We repurchase shares of our common stock from time to time after considering
market conditions and in accordance with repurchase limits authorized by our
Board. Under the share repurchase authorization, we may repurchase our shares
periodically over several years, depending on market conditions and other
factors, and may do so in open market purchases or privately negotiated
transactions. The share repurchase authorization has no expiration date. During
fiscal 2022, we repurchased 1.5 million shares of our common stock under this
authorization for an aggregate of
On
Contractual Obligations
As part of our ongoing operations, we enter into contractual arrangements that obligate us to make future cash payments. These obligations impact our liquidity and capital resource needs. In addition to principal and interest payments on our outstanding long-term debt and notes payable balances, discussed above, our contractual obligations primarily consist of lease payments, income taxes, pension and postretirement benefits, and unconditional purchase obligations.
A summary of our operating and finance lease obligations as of
The liability for gross unrecognized tax benefits related to uncertain tax
positions was
As of
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As of
Capital Expenditures
We continue to make investments in our business and operating facilities. Our
preliminary estimate of capital expenditures for fiscal 2023 is approximately
Supplier Arrangements
We offer certain suppliers access to a third-party service that allows them to
view our scheduled payments online. The third-party service also allows
suppliers to finance advances on our scheduled payments at the sole discretion
of the supplier and the third party. We have no economic interest in these
financing arrangements and no direct relationship with the suppliers, the third
party, or any financial institutions concerning this service. All balances
remain as obligations to our suppliers as stated in our supplier agreements and
are reflected in accounts payable within our Consolidated Balance Sheets. The
associated payments are included in net cash flows from operating activities
within our Consolidated Statements of Cash Flows. As of
The program commenced at about the same time that we began an initiative to negotiate extended payment terms with our suppliers. Although difficult to predict, we generally expect the incremental cash flow benefits associated with these extended payment terms to increase at a slower rate in the future. A number of factors may impact our future payment terms, including our relative creditworthiness, overall market liquidity, and changes in interest rates and other general economic conditions.
Cash Flows
In fiscal 2022, we generated
Cash generated from operating activities totaled
Cash used in investing activities totaled
Cash used in financing activities totaled
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Cash Held by International Subsidiaries
The Company had cash and cash equivalents of
CRITICAL ACCOUNTING ESTIMATES
The process of preparing financial statements requires the use of estimates on the part of management. The estimates used by management are based on our historical experiences combined with management's understanding of current facts and circumstances. Certain of our accounting estimates are considered critical as they are both important to the portrayal of our financial condition and results and require significant or complex judgment on the part of management. The following is a summary of certain accounting estimates considered critical by management.
Our Audit/
Marketing Costs-We offer various forms of trade promotions which are mostly recorded as a reduction in revenue. The methodologies for determining these provisions are dependent on local customer pricing and promotional practices, which range from contractually fixed percentage price reductions to provisions based on actual occurrence or performance. Our promotional activities are conducted either through the retail trade or directly with consumers and included activities such as in-store displays and events, feature price discounts, consumer coupons, and loyalty programs. The costs of these activities are recognized as a reduction of revenue at the time the related revenue is recorded, which normally precedes the actual cash expenditure. The recognition of these costs therefore requires management judgment regarding the volume of promotional offers that will be redeemed by either the retail trade or consumer. These estimates are made using various techniques including historical data on performance of similar promotional programs. Differences between estimated expense and actual redemptions are recognized as a change in management estimate in a subsequent period.
We have recognized trade promotion liabilities of
Income Taxes-Our income tax expense is based on our income, statutory tax rates, and tax planning opportunities available in the various jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in determining our income tax expense and in evaluating our tax positions, including evaluating uncertainties. Management reviews tax positions at least quarterly and adjusts the balances as new information becomes available. Deferred income tax assets represent amounts available to reduce income taxes payable on taxable income in future years. Such assets arise because of temporary differences between the tax bases of assets and liabilities and their carrying amounts in our consolidated balance sheets, as well as from net operating loss and tax credit carryforwards. Management evaluates the recoverability of these future tax deductions by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings, and available tax planning strategies. These estimates of future taxable income inherently require significant judgment. Management uses historical experience and short and long-range business forecasts to develop such estimates. Further, we employ various prudent and feasible tax planning strategies to facilitate the recoverability of future deductions. To the extent management does not consider it more likely than not that a deferred tax asset will be recovered, a valuation allowance is established.
Further information on income taxes is provided in Note 13, "Pre-tax Income and Income Taxes", to the Consolidated Financial Statements contained in this report.
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Employee-Related Benefits-We incur certain employment-related expenses associated with our pension plans. In order to measure the annual expense associated with these pension benefits, management must make a variety of estimates including, but not limited to, discount rates used to measure the present value of certain liabilities, assumed rates of return on assets set aside to fund these expenses, employee turnover rates, and anticipated mortality rates. The estimates used by management are based on our historical experience as well as current facts and circumstances. We use third-party specialists to assist management in appropriately measuring the expense associated with these pension benefits. Different estimates used by management could result in us recognizing different amounts of expense over different periods of time.
The Company uses a split discount rate (the "spot-rate approach") for the
We have recognized a pension liability of
We recognize cumulative changes in the fair value of pension plan assets and net
actuarial gains or losses in excess of 10% of the greater of the fair value of
plan assets or the plan's projected benefit obligation ("the corridor") in
current period expense annually as of our measurement date, which is our fiscal
year-end, or when measurement is required otherwise under
We recognized pension expense (benefit) from Company plans of
One significant assumption for pension plan accounting is the discount rate. We use a spot-rate approach, discussed above. This approach focuses on measuring the service cost and interest cost components of net periodic benefit cost by using individual spot rates derived from a high-quality corporate bond yield curve and matched with separate cash flows for each future year instead of a single weighted-average discount rate approach.
Based on this information, the weighted-average discount rate selected by us for
determination of the interest cost component of our pension expense was 2.29%
for fiscal 2022, 2.30% for fiscal 2021, and 3.51% for fiscal 2020. The
weighted-average discount rate selected by us for determination of the service
cost component of our pension expense was 3.50% for fiscal 2022, 3.35% for
fiscal 2021, and 4.04% for fiscal 2020. We selected a weighted-average discount
rate of 4.74% and 4.09% for determination of service and interest expense,
respectively, for fiscal 2023. A 25-basis point increase in our discount rate
assumption as of the end of fiscal 2022 would increase our annual pension
expense for our pension plans in fiscal 2022 by
Another significant assumption used to account for our pension plans is the
expected long-term rate of return on plan assets. In developing the assumed
long-term rate of return on plan assets for determining pension expense, we
consider long-term historical returns (arithmetic average) of the plan's
investments, the asset allocation among types of investments, estimated
long-term returns by investment type from external sources, and the current
economic environment. Based on this information, we selected 3.87% for the
weighted-average expected long-term rate of return on plan assets for
determining our fiscal 2022 pension expense. A 25-basis point increase/decrease
in our weighted-average expected long-term rate of return assumption as of the
beginning of fiscal 2022 would decrease/increase annual pension expense for our
pension plans by
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Business Combinations, Impairment of Long-Lived Assets (including property, plant and equipment), Identifiable Intangible Assets, and Goodwill-We use the acquisition method in accounting for acquired businesses. Under the acquisition method, our financial statements reflect the operations of an acquired business starting from the closing of the acquisition. The assets acquired and liabilities assumed are recorded at their respective estimated fair values at the date of the acquisition. Any excess of the purchase price over the estimated fair values of the identifiable net assets acquired is recorded as goodwill. Significant judgment is often required in estimating the fair value of assets acquired, particularly intangible assets. As a result, in the case of significant acquisitions we normally obtain the assistance of a third-party valuation specialist in estimating fair values of tangible and intangible assets. The fair value estimates are based on available historical information and on expectations and assumptions about the future, considering the perspective of marketplace participants. While management believes those expectations and assumptions are reasonable, they are inherently uncertain. Unanticipated market or macroeconomic events and circumstances may occur, which could affect the accuracy or validity of the estimates and assumptions.
We reduce the carrying amounts of long-lived assets to their fair values when their carrying amount is determined to not be recoverable. We generally compare undiscounted estimated future cash flows of an asset or asset group to the carrying values of the asset or asset group for property, plant and equipment. If the undiscounted estimated future cash flows exceed the carrying values of the asset or asset group, no impairment is recognized. If the undiscounted estimated future cash flows are less than the carrying values of the asset or asset group, we write-down the asset or assets to their estimated fair values. The estimates of fair value are generally in the form of appraisal, or by discounting estimated future cash flows of the asset or asset group.
Determining the useful lives of intangible assets also requires management judgment. Certain brand intangibles are expected to have indefinite lives based on their history and our plans to continue to support and build the acquired brands, while other acquired intangible assets (e.g., customer relationships) are expected to have determinable useful lives. Our estimates of the useful lives of definite-lived intangible assets are primarily based upon historical experience, the competitive and macroeconomic environment, and our operating plans. The costs of definite-lived intangibles are amortized to expense over their estimated life.
We reduce the carrying amounts of indefinite-lived intangible assets, and goodwill to their fair values when the fair value of such assets is determined to be less than their carrying amounts (i.e., assets are deemed to be impaired). Fair value is typically estimated using a discounted cash flow analysis, which requires us to estimate the future cash flows anticipated to be generated by the particular asset being tested for impairment as well as to select a discount rate to measure the present value of the anticipated cash flows. When determining future cash flow estimates, we consider historical results adjusted to reflect current and anticipated operating conditions. Estimating future cash flows requires significant judgment by management in such areas as future economic conditions, industry-specific conditions, product pricing, and necessary capital expenditures. The use of different assumptions or estimates for future cash flows could produce different impairment amounts (or none at all) for long-lived assets and identifiable intangible assets.
In assessing indefinite-lived intangible assets not subject to amortization for impairment, we have the option to perform a qualitative assessment to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of such an intangible asset is less than its carrying amount. If we determine that it is not more likely than not that the fair value of such an intangible asset is less than its carrying amount, then we are not required to perform any additional tests for assessing intangible assets for impairment. However, if we conclude otherwise or elect not to perform the qualitative assessment, then we are required to perform a quantitative impairment test that involves a comparison of the estimated fair value of the intangible asset with its carrying value. If the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.
If we perform a quantitative impairment test in evaluating impairment of our indefinite lived brands/trademarks, we utilize a "relief from royalty" methodology. The methodology determines the fair value of each brand through use of a discounted cash flow model that incorporates an estimated "royalty rate" we would be able to charge a third party for the use of the particular brand. When determining the future cash flow estimates, we estimate future net sales and a fair market royalty rate for each applicable brand and an appropriate discount rate to measure the present value of the anticipated cash flows. Estimating future net sales requires significant judgment by management in such areas as future economic conditions, product pricing, and consumer trends. In determining an appropriate discount rate to apply to the estimated future cash flows, we consider the current interest rate environment and our estimated cost of capital.
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In testing goodwill for impairment, we have the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not (more than 50%) that the estimated fair value of a reporting unit is less than its carrying amount. If we elect to perform a qualitative assessment and determine that an impairment is more likely than not, we are then required to perform a quantitative impairment test, otherwise no further analysis is required. We also may elect not to perform the qualitative assessment and, instead, proceed directly to the quantitative impairment test.
Under the qualitative assessment, various events and circumstances that would affect the estimated fair value of a reporting unit are identified (similar to impairment indicators above). Furthermore, management considers the results of the most recent quantitative impairment test completed for a reporting unit and compares the weighted average cost of capital between the current and prior years for each reporting unit.
Under the quantitative impairment test, the evaluation involves comparing the current fair value of each reporting unit to its carrying value, including goodwill. Fair value is typically estimated using a discounted cash flow analysis, which requires us to estimate the future cash flows anticipated to be generated by the reporting unit being tested for impairment as well as to select a risk-adjusted discount rate to measure the present value of the anticipated cash flows. When determining future cash flow estimates, we consider historical results adjusted to reflect current and anticipated operating conditions. We estimate cash flows for the reporting unit over a discrete period (typically five years) and the terminal period (considering expected long term growth rates and trends). Estimating future cash flows requires significant judgment by management in such areas as future economic conditions, industry-specific conditions, product pricing, and necessary capital expenditures. The use of different assumptions or estimates for future cash flows or significant changes in risk-adjusted discount rates due to changes in market conditions could produce substantially different estimates of the fair value of the reporting unit.
As of
With the addition of Pinnacle intangibles that were recorded at fair value in fiscal 2019, we continue to be more susceptible to impairment charges in the future if our long-term sales forecasts, royalty rates, and other assumptions change as a result of lower than expected performance or other economic conditions. We will monitor these assumptions as management continues to achieve gross margin improvement, and long-term sales growth on certain key brands acquired in the acquisition including, but not limited to, Birds Eye®, Duncan Hines®, Gardein® and Vlasic®.
During the first quarter of fiscal 2023 (on
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Assumptions used in impairment testing are made at a point in time and require significant judgment; therefore, they are subject to change based upon the facts and circumstances present at each impairment test date. We have not completed our goodwill impairment assessment necessitated by the change in internal reporting structure, but we believe it is likely that we will incur a material impairment charge in the first quarter of fiscal 2023 as a result of current economic conditions, including a significant increase in interest rates since our last quantitative goodwill impairment test. Any implied goodwill impairment would also trigger a reassessment of fair value for our indefinite-lived intangibles that are within the respective reporting unit and may also result in a material impairment charge.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The principal market risks affecting us during fiscal 2022 and 2021 were exposures to price fluctuations of commodity and energy inputs, interest rates, and foreign currencies.
Commodity Market Risk
We purchase commodity inputs such as wheat, corn, oats, soybean meal, soybean oil, meat, dairy products, nuts, sugar, natural gas, electricity, and packaging materials to be used in our operations. These commodities are subject to price fluctuations that may create price risk. We enter into commodity hedges to manage this price risk using physical forward contracts or derivative instruments. We have policies governing the hedging instruments our businesses may use. These policies include limiting the dollar risk exposure for each of our businesses. We also monitor the amount of associated counter-party credit risk for all non-exchange-traded transactions.
Interest Rate Risk
We may use interest rate swaps to manage the effect of interest rate changes on the fair value of our existing debt as well as the forecasted interest payments for the anticipated issuance of debt.
As of
Foreign Currency Risk
In order to reduce exposures for our processing activities related to changes in foreign currency exchange rates, we may enter into forward exchange or option contracts for transactions denominated in a currency other than the functional currency for certain of our operations. This activity primarily relates to economically hedging against foreign currency risk in purchasing inventory and capital equipment, sales of finished goods, and future settlement of foreign denominated assets and liabilities.
Effect of Hypothetical 10% Fluctuation
We changed the disclosure alternative for reporting our commodity and foreign exchange derivatives (inclusive of commodity and foreign exchange swaps, futures, forwards, and options) in the second quarter of fiscal 2022 from a value-at-risk ("VaR") model to a hypothetical sensitivity analysis. The change in the methodology was made to simplify and enhance the information presented about the sensitivities of our derivative positions.
The potential gain or loss on the fair value of our outstanding commodity and foreign exchange contracts, assuming a hypothetical 10% fluctuation in commodity prices and foreign currency exchange rates, would have been (in millions):
Fair Value Impact
Average During Average During
the Fiscal Year the Fiscal Year
Ended May 29, Ended May 30,
In Millions 2022 2021
Energy commodities $ 0.9 $ 3.5
Agriculture commodities 4.9 6.9
Foreign exchange 10.8 11.8
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It should be noted that any change in the fair value of our derivative
contracts, real or hypothetical, would be significantly offset by an inverse
change in the value of the underlying hedged items. In relation to foreign
currency contracts, this hypothetical calculation assumes that each exchange
rate would change in the same direction relative to the
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