Lamb Weston Holdings, Inc.

Good day and welcome to the Lamb Weston second quarter 2021 earnings call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Dexter Combley, VP Investor Relations of Lamb Weston. Please go ahead.

Good morning, and thank you for joining us for Lamb Weston's second quarter 2021 earnings call. This morning, we issued our earnings release, which is available on our website, lambweston.com. Please note that during our remarks, we'll make some forward-looking statements about the company's expected performance. These statements are based on how we see things today. Actual results may differ materially due to risks and uncertainties. Please refer to the cautionary statements and risk factors contained in our SEC filings for more details on our forward-looking statements. Some of today's remarks include non-GAAP financial measures. These non-GAAP financial measures should not be considered a replacement for and should be read together with our GAAP results. You can find the GAAP to non-GAAP reconciliations in our earnings release. With me today are Tom Warner, our President and Chief Executive Officer, and Rob McNaught, our Chief Financial Officer. Tom will provide an overview of the current operating environment, while Rob will provide some details on our second quarter results, as well as some shipment trends for the third quarter. With that, let me now turn the call over to Tom.

Thank you, Dexter. Good morning, and thank you for joining our call today.

We delivered solid financial results in the second quarter as our entire Lamb Weston team continues to execute well through this challenging environment. That's only possible because of their ongoing commitment to serving our customers, suppliers, and communities, and I can't thank them enough for their dedication and support. Our second quarter results also reflect operating conditions that were generally similar to what we experienced in the first quarter. Overall, restaurant traffic in the U.S. was resilient by holding steady at around 90% of pre-pandemic levels for much of the quarter. However, traffic and frozen potato demand rates continued to vary widely by channel. Traffic at large chain restaurants were essentially at prior-year levels as quick-service restaurants continued to leverage drive-through, take-out, and delivery formats. Traffic at full-service restaurants was 70% to 80% of prior year levels for much of the quarter. However, traffic began to soften in November as governments reimposed social and on-premise dining restrictions in an effort to contain the resurgence of COVID and as the onset of colder weather tempered outdoor dining opportunities across many markets. Traffic and demand at non-commercial customers, which includes lodging, hospitality, healthcare, schools and universities, sports and entertainment, and workplace environment was fairly steady at around 50% prior year levels for the entire quarter. In retail, consumer demand continued to be strong with weekly category volume growth between 15% and 20% versus the prior year. Outside the U.S., Restaurant traffic and fry demand were uneven across markets and varied within the quarter. In Europe, which is served by our Lamb, West, and Meyer joint venture, fry demand during much of the quarter was similar to last year, but softened to 75% to 85% at prior year levels during the latter part of the quarter as governments reimposed social restrictions and as the weather turned colder. As you may recall, unlike in the U.S., QSRs in Europe generally have only limited drive-through capabilities. Demand in our other key international markets was mixed. In China and Australia, demand was near prior year levels. In our other key markets in Asia and Latin America, overall demand improved sequentially from our first quarter, but remained well below prior year levels. Going forward, we expect many of the softer traffic and demand trends that we began to see in November to carry over into our fiscal third quarter. The sharp resurgence of COVID in the U.S. and Europe has led governments to impose even more rigid social restrictions. In addition, we expect outdoor restaurant dining traffic in our largest markets to fall further as we enter the coldest months of the year in the Northern Hemisphere. Not surprisingly, we expect traffic at full-service restaurants will continue to be disproportionately affected. Major QSR chains in the U.S. should be able to continue to hold up well due to their ability to serve customers via drive-through and delivery. Retail should also benefit as consumers eat more meals at home. And as Rob will discuss later, while still early, our shipments to those channels in December support that view. So on the one hand, in the near term, we anticipate facing even more challenging and volatile operating conditions than what we experienced in the first half of our fiscal year. On the other hand, we believe this COVID-induced shock to demand is temporary. We're confident in the strength of the frozen potato category and do not see any structural impediments to recovery in demand and growth over the long term. As COVID vaccines become more widely available in the coming months and as the virus is more broadly contained, we expect governments will gradually lift social restrictions. This should lead to steady growth in restaurant traffic as the year progresses. We believe this growth will lead to overall frozen potato demand approaching pre-pandemic levels on a run rate basis by the end of calendar 2021. In the meantime, we're confident in our business fundamentals of pricing, capacity utilization, and potato supply, and our ability to manage through the pandemic's impacts on our manufacturing operations. Our recently announced increase in our quarterly dividend and the planned resumption of our share repurchase program reinforce our conviction in the strength of our business and the category, as well as our commitment to support customers and create value for our stakeholders. In summary, we delivered solid Q2 results and are executing well in a challenging environment. We expect frozen potato demand to soften in the near term due to reduced traffic following government reimposed social restrictions, as well as the onset of colder weather. And we're optimistic that the increasing availability of COVID vaccines will enable restaurant traffic to gradually improve as the year progresses. And that demand will approach pre-pandemic levels by the end of calendar 2021. Now, let me turn the call over to Rob. Thanks, Tom. Good morning, everyone. As Tom noted, we delivered solid financial results in the second quarter. as our teams continued to manage through an ever-changing demand environment, as well as COVID-related disruptions to our manufacturing and distribution networks. For the quarter, net sales declined 12% to $896 million. Sales volume was down 14%, largely due to fry demand at restaurants and food service being negatively impacted following government-imposed restrictions to contain the spread of COVID. as well as colder weather beginning to limit outdoor dining across many of our markets. In addition, volume was down as we lapped the benefit of additional shipping days related to the timing of Thanksgiving last year. Overall, as Tom described earlier, restaurant traffic and our sales volumes in the U.S. stabilized at approximately 90% of pre-pandemic levels. although performance varied widely by sales channel. International sales were mixed but improved sequentially versus our first quarter. Price mix increased 2% driven by improved price in our food service and retail segments, as well as favorable mix in retail. Gross profit declined $62 million as lower sales and higher manufacturing costs more than offset the benefit of favorable price mix and productivity savings. As we discussed in our previous earnings call, we expected our manufacturing costs to increase in the quarter. This was partly due to processing potatoes from the 2019 crop through early September, which is a couple of months longer than usual. We did this in order to manage finished goods inventories in light of the pandemic's impact on dry demand. Processing older crop results in increased cost due to higher raw material storage fees and lower recovery rates. Since we typically carry upwards of 60 days of finished goods inventory, we realized the impact of these costs in our second quarter income statement as we sold that inventory. We also realized higher manufacturing costs due to input cost inflation, primarily related to edible oils, raw potatoes, and other raw ingredients. Overall, our input cost inflation was in the low single digits. Finally, we continue to realize incremental costs and inefficiencies resulting from the pandemic's disruptive effect on our manufacturing and supply chain operations. As a reminder, these costs largely relate to labor, and other costs to shut down, sanitize, and restart manufacturing facilities impacted by COVID, costs associated with modifying production schedules, reducing run times, and manufacturing retail products on lines primarily designed for food service products, and costs for enhancing employee safety and sanitation protocols, as well as for incremental warehousing, transportation, and supply chain costs. Specifically in the quarter, we had notable disruptions in our facilities in Idaho, as well as lesser ones in some other facilities. We expect to continue to incur COVID-related costs through at least the remainder of fiscal 2021. As a result, we consider these costs and disruptions as part of our ongoing operations and are no longer disclosing these costs separately. SG&A declined by nearly $8 million in the quarter. largely due to lower incentive compensation expense accruals and a $3.5 million reduction in advertising and promotional expense. The decline was partially offset by investments to improve our operations and IT infrastructure, which included about $5 million of non-recurring consulting and training expenses associated with implementing Phase I of our new ERP system. Equity method earnings. were $19 million, which is up $4 million versus last year. Excluding the impact of unrealized mark-to-market adjustments, equity earnings increased about $2 million due to better performance by our European joint venture. However, like in the U.S., our shipments softened during the latter part of the quarter, reflecting the effect on restaurant traffic of governments reimposing social restrictions, as well as colder weather on outdoor dining. EBITDA, including joint ventures, was $213 million, which is down $48 million. The decline was driven by lower income from operations and was partially offset by higher equity method earnings. Diluted EPS in the quarter was 66 cents, down 29 cents, largely due to lower income from operations. EPS was also down due to higher interest expense reflecting our higher average total debt and the write-off of some debt issuance costs as we paid off a term loan a year early. The decline was partially offset by higher equity earnings. Moving to our segments, sales for our global segment, which generally includes sales for the top 100 North American-based QSR and full-service restaurant chains, as well as all sales outside of North America, were down 12% in the quarter. Volume was down 11% due to softer demand for fries outside the home, especially in our international markets. Shipments to large chain restaurant customers in the U.S., of which approximately 85% are to QSRs, approached prior year levels as QSRs leveraged drive-through and delivery formats. However, some of that strength also reflected pulling forward sales of customized and limited time offering products from the third quarter. International sales, which historically comprised about 40% of segment sales, were at about 80% of prior year levels in the aggregate, but varied by market. Shipments in China and Australia approached prior year levels. Our shipments to other parts of Asia and Latin America improved sequentially as customers and distributors in many of these markets were able to right-size inventories. However, they remained well below prior year levels. Price mix declined 1% as a result of negative mix. Price alone was flat. Global's product contribution margin, which is gross profit less A&P expense, declined 28% to $93 million. Lower sales volume, higher manufacturing costs, and unfavorable mix drove the decline. Sales for our food service segment, which services North American food service distributors and restaurant chains generally outside the top 100 North American restaurant customers, declined 21% in the quarter. Volume declined 25%. Segments to smaller chain in independent full-service and quick-service restaurants tracked around 70% to 80% of prior year levels through much of October, but slowed to 60% to 70% in November following governments reimposing social restrictions and as colder weather tempered restaurant traffic in some of our markets. Shipments to non-commercial customers improved modestly since summer, but remained at around 50%. of prior year levels, with strength in health care more than offset by continued weakness in the other channels. Price mix increased 4% behind the carryover benefit of pricing actions taken in the latter half of fiscal 2020. Mix continued to be unfavorable with some hard-hit independent restaurants looking to reduce costs by purchasing more value-added products rather than the premium Lamb Westin branded ones. While we've regained much of this business since the pandemic first struck last spring, on a year-over-year basis, it remains a mixed headwind. Food services product contribution margin declined 21% to $88 million. Lower sales volumes, higher manufacturing costs, and unfavorable mix drove the decline and was partially offset by favorable price. Sales for our retail segment increased 7% in the quarter. Price mix increased 7%, primarily reflecting favorable mix benefit of selling more of our higher margin branded portfolio of Alexa, Alexia, Grown in Idaho, and licensed restaurant trademarks. Volume increased nominally. Sales of our branded products were up about 30%, which is well above category growth rates which ranged between 15 and 20%. The increase in our branded volume was offset by the loss of certain low margin private label volume that began late in the second quarter of fiscal 2020, as well as an additional amount that began a couple of months ago. As a result, we expect private label losses to continue to be a headwind. Retail's product contribution margin increased 6% to $30 million. The increase was driven by favorable mix and lower ANP expense and was partially offset by higher manufacturing costs. Moving to our cash flow and liquidity position, we're comfortable with our liquidity position and confident in our ability to continue to generate cash. In the first half, we generated nearly $320 million of cash from operations, which is down about $25 million versus last year due to lower sales and earnings. We spent $54 million in CapEx, including expenditures for our new ERP system. We paid $67 million in dividends and a few weeks ago announced a 2% increase in our quarterly dividend. In addition, we plan to resume our share repurchase program this quarter. As you may recall, we temporarily suspended our buyback program in late fiscal 2020 in order to help preserve our liquidity during the early days of the pandemic. As we discussed in our previous earnings call, in September, we amended our credit agreement to put in place a new three-year $750 million revolve. At the same time, using a portion of the more than $1 billion of cash on hand, we prepaid the approximately $270 million outstanding balance on the term loan that was due in November of 2021. At the end of the second quarter, we had more than $760 million of cash on hand, and our new revolver was undrawn. Our total debt was $2.75 billion, and our net debt to EBITDA ratio was 3.1 times. Now turning to our shipments so far in the third quarter. Broadly speaking, in the U.S., demand at QSRs and at retail are holding up well, while traffic at full-service restaurants continues to soften. Specifically, U.S. shipments in the four weeks ending December 27th were approximately 85% of prior year levels. In our global segments, shipments to our large QSR and full service chain customers in the U.S. were more than 95% of prior year levels. We expect that rate will largely continue for the remainder of the third quarter. In our food service segment, shipments to our full-service restaurants, regional and small QSRs, and non-commercial customers in aggregate were 60 to 65 percent of prior year levels. That is largely in line with what we realized during the latter part of the second quarter. We anticipate that shipments to full-service restaurants and small and regional QSRs will continue to soften as social restrictions broaden and as winter weather takes a bigger bite out of outdoor dining. Shipments to non-commercial customers, which have historically comprised about 25% of the segment's volume, were roughly half of prior year levels and will likely remain soft for the remainder of the quarter. In our retail segments, shipments were above prior year levels with strong volume of our branded products, partially offset by a decline in shipments of private label products. We believe that this rate will largely continue for the remainder of the quarter. Outside the U.S., overall demand has slowed, but it's varied by market. In Europe, shipments by our Lamb, West, and Meyer joint venture were approximately 85% of prior year levels, continuing the softer demand that we realized during the latter part of the second quarter. We believe that shipments will continue to soften due to severe social restrictions and colder weather. Shipments to our other international markets, which primarily include Asia, Oceania, Latin America, were mixed. In aggregate, international shipments so far in the quarter have been softer than what we realized during the latter half of the second quarter. As a reminder, all of our international sales are included as part of our global In short, other than at US QSRs, which can leverage drive-through access, global demand for fries at restaurants and food service will be soft in the third quarter, following governments reimposing restrictions to combat the resurgence of COVID, as well as colder weather in our northern hemisphere markets limits outdoor dining opportunities. With respect to contract pricing, after completing discussions for contracts that were up for renewal, we expect pricing across our domestic large chain restaurant portfolio in aggregate to be flat versus prior year. Outside of these large chain restaurant contracts, on balance, domestic pricing is holding up well. However, we continue to see increased competitive activity in more value-oriented products in some international markets, and to a lesser extent, in some value-tiered domestic market segments. With respect to costs, the potato crop in our growing regions in the Columbia Basin, Idaho, Alberta, and the Upper Midwest is consistent with historical averages in aggregate. We don't see any notable impact on cost outside of inflation. Crop in our growing areas in Europe is also broadly consistent with historical averages which should help ease cost pressures there versus last year. However, we do expect to continue to incur additional costs as a result of COVID's disruptive impact on our manufacturing and supply chain operations. And we expect that we'll continue to do so until the virus is broadly contained. Now here's Tom for some closing comments. Thanks, Rob. Let me just quickly sum up by saying, while the near-term environment will be volatile, we believe that the restaurant traffic will gradually recover to pre-pandemic levels by the end of calendar 2021. We'll continue to focus on the right strategic and operating priorities to serve our customers and build upon the long-term health of the category in order to create value for our stakeholders.

Thank you for joining us today, and we're now ready to take your questions.

Thank you. Ladies and gentlemen, if you wish to ask a question at this time, please signal by pressing star 1 on your telephone keypad. Please ensure the mute function on your telephone is switched off to allow your signal to reach our equipment. Again, please press star 1 to ask a question. And we can take our first question from Andrew Lazar of Bear Place. Please go ahead.

Morning, everybody, and Happy New Year. Morning, Andrew. Happy New Year. Two questions for me, if I could. First, You know, with visibility to getting back to pre-pandemic levels of demand by calendar year end, I'm curious if there are any signs you are seeing of any lasting, you know, shifts in competitive dynamics among sort of the key North American players that could result in Land West and coming out of this in a stronger, you know, relative position than it went in.

Yeah, Andrew, so I think, you know, right now the industry,

We're all navigating through, you know, the pandemic. And, you know, from a land western standpoint, our strategy has not changed. And, you know, while we have paused a few things that we were thinking about pre-pandemic, I will tell you that we're actively engaged in some projects. And it's all about positioning this company as, you know, as we believe the demand is going to return by calendar year. And if you think about 18 months from now, we've got to be ready to capture share demand across the whole globe. So while we have paused a few things, we have re-engaged in some things, projects that we're working on, and we're going to move those forward and get ourselves in position. 12 to 18 months from now to capture the demand that we believe is going to come back to pre-pandemic levels.

That's a good segue into my second question, which is, you know, I know it's an odd time in some regards to ask about, you know, incremental industry capacity, but, you know, if you see frozen potato demand approaching pre-pandemic levels again by calendar year end, and then, you know, assuming demand globally grows at, you know, normalized levels from there, and knowing it takes a few years to get, you know, new capacity for the industry online, when would you think we might hear of new, you know, industry capacity additions being announced, whether that be, you know, Land Weston or others?

Yeah, you know, one of our competitors, you know, they're in the process of expanding capacity that they were working on pre-pandemic, right? You know, from our standpoint, again, we've got some things that we're moving forward and, you know, at the right time, and we'll do all the work around it. We'll make that decision. The other thing that, you know, one of the silver linings with all this is we've really focused internally on our efficiency and operating efficiencies within our current footprint, and it's – given us visibility to opportunities we believe within the current manufacturing footprint to unlock capacity. So, you know, that's something that the supply chain team in Lamb-Wesson is focused on. We have a big initiative within supply chain to unlock capacity and drive efficiencies. And, you know, if you think about, Andrew, the timing of you know, new capacity versus what we have in our current footprint, I'm 100% confident that with our supply chain initiative unlocks hidden capacity in our current footprint that we're absolutely in a great position as demand returns to support, you know, not only our current customers as their business returns, but also future demand and category growth. So I feel we're in a really good position. But, again, at the right time, we've got to make those decisions in terms of getting ourselves ready for demand resurgence 18, 24 months out. Great.

Thanks for your time. Yep.

And we can now take our next question from Adam Samuelson of Goldman Sachs. Please go ahead.

Yes, thanks. Good morning, everyone. Morning, Adam. Morning, Adam. Morning. Hi. So I guess my, uh, my first question is really related to some of the pricing comments that you made, uh, you made earlier and just some of where you're seeing some of that incremental competitive activity, um, internationally, is that, would you presume that's in your export markets out of the U S not in the European JV, but is that European competitors who are looking to push into Asia? Just help me think about kind of frame kind of where you're seeing that and is that places that haven't played before?

And then domestically on the value tier side, is that just European imports into the East Coast?

Just help me think about the origin of that competitive thread and kind of how salient and how much of your volumes are really kind of framing and the exposure there. Yeah, Adam, this is Rob. In terms of the pricing in the international, it is a mix of where that's coming from, the competitive. Some of that in some markets where there is some of that lower-end production is coming from local producers just running the cash flow, and some of it is coming from excess capacity in Europe. Similarly, in the U.S., again, it's in that lower-end value market, and we have seen some increases from the Europeans that is certainly having some impact in that limited part of the market.

And just anyway, Tom, you can help think about just how much that

your business is really in those kind of categories where you're seeing, I'm trying to contextualize kind of the pockets where there is some, a little bit of competitive intensity.

Yeah. And we don't, we don't necessarily disclose that, but, but to Rob's point, it's, it's the lower line flow, what we call it. So it's really not a material piece of our business. The point is, you know, it's more pronounced in Asia. And the Europeans are being competitive in Asia. And, you know, it's not one market specifically. It's random markets in Asia. And, you know, our team's doing a good job trying to hold serve. But, you know, when you get in those situations, you know, customers are going to think about going a different direction. But, you know, we're watching it closely. It is more pronounced than it has been. but I will say, you know, it's nothing that we're not used to dealing with. It's just more aggressive and, you know, the team will work through it and capture opportunities where we can.

Okay. That's really helpful.

And then just my second one was going to be, and I think about the fiscal third quarter and kind of volumes kind of slowing down from where they were. I mean, it seems,

seemingly a little bit more orderly than it might have been in the spring.

I'm just trying to make sure I'm sensitive and thinking about the gross margin kind of implications of softer volumes in the near term and just kind of the levers you can pull or just the ability to plan better to manage that kind of lower volume near term.

Yeah, I'll talk to the patterns, and then, Rob, you can hit the margin. You know, if you think back through the initial – start of the whole pandemic, you know, our business evaporated. We're down 60% in total, 50, 60%. So, you know, as we look over this next quarter, while our, you know, we're seeing softness in some of the channels, specifically food service, I don't believe it's going to be anywhere near it was when all this thing started. Now, that said, you know, we gave guidance on what's happening, you know, through December. And, you know, I think that's going to be where it plays out over the next 30, 60 days. We'll get through winter. Things are going to open them back up. The most important thing for us – is to be prepared for the opening back up. And we learned a lot of lessons last spring as a management team and myself personally that we have to be ready. And what does that mean? It means if you think about April, May, we're taking some measures right now to ensure we've got the right inventory, the right products, so when demand snaps back, which we believe it will in the spring and start increasing, we can service our customers. All the while, recognize that we're still dealing with manufacturing operating issues because of COVID in terms of efficiencies. So on the one hand, while things are slowing down in some areas, on the other hand, it's a great opportunity for us to get ourselves positioned to meet demand when this thing snaps back. So You know, the near term is going to be volatile, but as we come out, you know, get to spring and summer and you've got vaccines and this thing hopefully starts getting behind us, you know, I believe there's going to be some pent-up demand for people to get out and go out and eat again. And, you know, so we're going to be prepared for that.

Okay, great. That's a really helpful comment. I'll pass it on. Thank you.

We can now take our next question from Rob Vickerson of Jefferies. Please go ahead.

Great. Thank you very much.

So just to kind of circle back, a couple of comments you made on kind of, you know, where you are now in terms of, you know, your inventories and kind of how you have to be ready, right, for a potential demand snapback, and let's call it April, May, June, whatever it is. How do you feel, I guess, for, you know, around or about Lamb Weston's kind of current inventory levels and maybe the industry's inventory levels kind of vis-a-vis, right, some of this kind of hopefully temporary softness in the Q3 and part of the business, right? If you step back, you say, okay, this is where we are now. It's how many potatoes we have, how many potatoes the industry has. I feel like we kind of, you know, forecasted it somewhat appropriately relative to demand when we go back to, right, March, April of last year. And now, as you sit here and you think about Q3 into the, you know, into the spring and summer, do you kind of say, yeah, you know, we still feel pretty good. The industry feels pretty good about those inventory levels as long as that demand does snap back. So we're not once again, kind of, you know, so to speak over inventory. Is that fair? Yeah, I think I, my point of view is I, you know, I believe the industry's balanced from, from Land West's standpoint. We're, We're balanced. I feel good about where we're at on raw availability and what we have in storage to meet the needs. Even if there's a return to demand, I think we're in good shape. The thing that we're working on right now is to make sure we've got the right inventory levels of product that – was really pulled when the economy opened back up in May, June. And so we've got data, and we can look and see what the customers, the products, they were – we were shipping to them. So we're positioning those products to have – a different level of safety stock, if you will, to anticipate that. And, you know, so I think we're in good shape. We've finished good inventory, raw inventory. The thing to remember is, you know, the timing of, you know, whether it's April, May, or June, the timing of consumer demand going out to eat more, maybe it's further down the road. we'll manage it, and we can manage our production schedules. We can manage inventory levels. So, you know, there's things we can do and have done and always do just to manage the supply and demand side of it. And so I feel good about where we're at now. Like I said, we're getting ourselves prepared for demand returns. as we get through Q3 and I think the company will be in good shape and we'll react as needed just based on the ordering signals we're getting from our customers. Rob, the other point I'd make or the distinction, initially when the pandemic first hit demand, it felt like we don't have perfect insight into the downstream distribution through the channel. but it felt like they were working with old models. And so the orders continued to come even as end user demand was coming off. We're seeing a quicker adjustment in that now. And so I think as we've learned, they've also learned. And so I'm not concerned about downstream channel being overloaded. Okay, great.

And then this might be too specific of a modeling question, but I'll give it a shot.

So, you know, in your global division, right, organic sales declined 12%, but on a tier stack basis, like given the extra shipping days, maybe some LTOs is essentially flat, right? So that's pretty good, all things considered. I'd argue, if I'm thinking about Q3, right, you don't have, you know, that big tough compare, so to speak, on the volume side, I'm just speaking to global. So, you know, is there, you know, like, should we be thinking on the global side that, you know, sales, the trajectory of that year over year should, in theory, really improve, right? Assuming that, you know, shipments are still, you know, pretty good, you know, relative to pre-pandemic. Because it kind of, it feels like, you know, we kind of all want to model down still, you but obviously the year ago does matter. So just any color on that would be helpful. Thanks. Yeah, I would say that in the QSR side, the big QSRs, that demand seems to be just fine there. They've figured out the model, and they're leveraging the drive-throughs and so forth. There are other parts of that business that – you know, sell to more sit-down restaurants. And that's going to continue to look like our food service. And then in our international sales, okay, again, that varies by country. We cited China and Australia being relatively strong. But there are some other international locations which aren't as strong. Europe in particular. Now, recognize Europe's not in our sales line. It's down in the equity earnings. And so... In Europe, the QSRs don't have the drive-through, so we'll have some headwinds there just because they don't have the same model. Okay, and then just the last thing very quickly, I feel like I kind of have to ask. In the past month or so, I've had a lot of investors kind of come to me and say, oh, we've heard there might have been some contract pressure with the larger QSR domestically. I have no evidence of that. I don't hear you speaking to it. Sounds like things are pretty good, so to speak, from what I'm hearing. So, kind of give you the opportunity to address that. And I just ask because I've had so many people ask me, is there any contract pressure in any larger QSRs? And that's all. Thanks. Yeah, we don't specifically talk about customers and negotiations. What I will tell you is just like every other year, we go through contract season with our customers, so to speak. And just like last year, just like the year before, this year we kind of came through as we expected. And, you know, so that's generally where we ended up.

Okay, perfect. Thanks, guys. Appreciate it. Thank you.

And we can now take our next question from Tom Palmer of JPMorgan. Please go ahead.

Good morning, and thanks for all the detail on current trends. In the press release and in the prepared remarks, you mentioned your view that the overall frozen potato industry demand could approach pre-pandemic levels by the end of this calendar year. I just wanted to clarify how this would apply to Lamb Weston. Would you assume that the company's sales trends would be comparable to the overall industry, or are there reasons why you might diverge from the industry either because of a different channel mix than the industry or because of some customer wins or losses that have been taking place?

Yeah, Tom, this is Rob.

In terms of our overall performance, again, The food service business, you know, that's where we expect to see the snapback. As we've talked about, the QSRs have largely kind of held their own. So really in the food service is where we'll see a lot of that strength. And then some of those international markets that we've talked about that have been a little more challenged. And so those are the areas where we think we'll see the strength. And, again, as Tom talked about, in terms of – The capacity unlock that the supply chain team is working on, you know, while we haven't spent the capital for a new line per se, the guys are figuring out some ways to get some capital out. So if you think about that, the ability to service that capacity, I think our international sales team is well set up and well positioned. And we've talked about our food service sales team with that direct sales model that we went to. being in a favored position relative to maybe some of our competitors who are more broker-oriented that adjusted their service model a little bit, their cost to that. And so we do feel good that we'll have relative opportunities.

Okay. So just to clarify what you mean by that is you think you could either grow with the industry, if not better, when you say return to pre-pandemic.

Exactly. Okay, thank you.

And then just wanted to ask, you wrapped up prepared remarks with the commentary on contract renegotiation. I just wanted to clarify exactly what this means. So if you're saying that the contracts that were renegotiated this year were flat, and then should we assume that the the contracts that kind of roll over have the typical price increases that are normally baked into them, and so kind of the net-net of your contract basket would be positive, or do you mean the net-net would be flattish?

Well, the contracts, as I stated earlier, that we talked about and worked on this year and got negotiated were at what we expected. And we don't necessarily get into the economics of that. So it's just we got through it just like we do every other year. And, you know, there's some contracts that we have that there is inflationary pricing mechanisms that are adjusted every year. And, you know, those contracts are in place, you know, automatically – the changes based on inflation just gets passed through. So, you know, that's where we're at. Just like every other year, nothing's really changed.

Okay, understood. Thank you.

And we can now take our next question from Brian Spillano, Bank of America. Please go ahead.

Hey, thank you, Operator, and happy new year, everyone. Happy new year, Brian. Thank you. So maybe just to pick up first on Tom's question around inflation and pricing, and I guess more on just focused on inflation. Can you give us sort of an update on what you're seeing now? I think cooking oils have inflated recently, and we know that freight costs are higher. I don't really know or would like to maybe get some insight to is in terms of grower inflation, just is there inflation in things like, I don't know, fertilizer, seed potatoes, water, just trying to get a sense of whether or not, you know, the industry or you'll feel maybe a little bit more input inflation as we move into the out year versus what you've seen over the last few years.

Yeah, Brian, I'm going to address the crop. As we do every year, we don't get into specifics until we get through the negotiating, which that's happening as we're talking here. So down the road, July, October, we'll talk about what the overall crop is looks like and the economics of all that, just like we do every year. Brian and Rob, if you think about it, a lot of that's driven by energy fuel, whether it's diesel to run the tractor or whether it's gas going into fertilizer production, things like that. Those tend to move together. You mentioned edible oils specifically, and, yeah, there's been a little bit of an upswing in the market. Recognize we do hedge and enter into longer-term contracts in that. And so if you put all that together, I think that low single-digit inflation overall is what we're looking at in the near term. And as Tom said, as we go through raw negotiations, we'll see how that comes out.

Okay. And then just the second one related to innovation, you know, pre-pandemic, you look at last year and there was some nice, you know, upside, I guess, from some of the limited time offers and some of the more value-added innovation, you know, particularly with QSRs. So, you know, as we start to normalize, is there – can you give us just some color on kind of what the innovation pipeline may be looking like and whether there's maybe a little bit of, you know, maybe a pipeline, I guess, that's maybe backed up a little bit in terms of getting some new products and some innovation into the market just because, you know, it's been so disrupted over the last, you know, 10 or 11 months.

Yeah, Brian, I, you know, you can – understand this. I'm not going to get into a lot of the specifics of some of the things we're working on. We do have a full pipeline. I will tell you one thing that we are accelerating is our Crispion delivery offering. We came out with that about 15 months, 18 months ago. We're applying that technology to some different fry formats. So, you know, with the, and it's right in the sweet spot of delivery and drive-through and all those kind of things. And, you know, we're getting some traction on it. It's a small base, but it's, the growth on crispy on delivery is accelerating.

Okay, great. Thanks, guys.

We can now take our next question from Chris Crowe of Steeple. Please go ahead.

Hi, good morning. Happy New Year as well to you. Good morning, Chris.

Hi, good morning. Just had a couple questions then. The first one would just be a bit of follow-on to earlier questions. You did note the higher cost of processing potatoes out of storage that have been in storage longer. I'm just trying to get a sense of your potato supply and the adjustments you've made to supply to potentially avoid that risk later in the year. Do you feel like you're in a good place on the supply and therefore the future costs for processing those potatoes? Yeah, Chris, like I said earlier, we're very well balanced with raw needs based on our latest forecast for the remainder of the year. So I feel very comfortable where we're at. And, you know, just in terms of the raw cost impact, you know, with the demand change last spring, summer, store and run potatoes longer than we ever had. And the implications of that is you just don't get the yield that we're used to based on it stores longer and it just doesn't perform in the factories as well as the longer you store it. So we're through all that. You know, going forward with, you know, the current crop and storage, we will process that on a normal timeline as we have in previous years. So it was just a one-off. It was a decision based on the change in demand to utilize the old crop longer. But that's all behind us now.

Okay. That makes sense.

I just want to be clear on that. I just have a second question.

We've had a number of questions around the large chain contracts and some of the potential pricing elements. I'm just curious, are the one-time things you're doing or – They may weigh on pricing a bit, but are meant to drive better demand. I know we've talked about limited-time offerings, quite the opposite of that. That could be an item that restaurants use to try to regenerate demand. Are there other things they're doing that are more pricing and promotion-driven in the short term that weigh on gear pricing in those large contracts? No, we're not seeing anything, any change that's driving demand. The interesting thing, Chris, we obviously look at all kinds of different data. The encouraging thing is the importance of fries on menu is at an all-time high. Now, in theory, if you say, look, if that holds as demand returns, that's going to further add to overall french fry demand going forward and you know that's that's an interesting thing that we're monitoring right now to understand and whether that holds or not remains to be seen but you know again you look for positives in this and that's one thing that is really intriguing to us because that could be if it holds to the level it's holding on the importance menu importance You know, that's going to elevate demand even further than what we believe it's going to come back by the end of the calendar year, which is close to pre-pandemic levels.

Okay. Thank you for that. Yep.

We can now take our next question from William Rotter of Bank of America. Please go ahead.

Good morning. I just have two quick ones. Last quarter, you laid out what the one-time costs were associated with COVID. I was wondering if you could lay out that again for the second quarter, and then what of those will remain post-COVID?

Yeah, this is Rob.

In terms of the detail of that cost, we've really concluded that those are just part of our operating costs now. And frankly, You know, if you go back to the first quarter of the pandemic when we took a write-off on raw and we were shutting down lines for, you know, for a long period of time, they were real easy to carve out. We did give some detail on like, you know, what the increased sanitation protocols and so forth and PPE and so forth are in the plants. And that continues on. The rest of it, you know, as you bring in lines up and down, it's become – more difficult to really separate out what's operating versus COVID. And so, you know, it's just embedded into our cost structure on an ongoing basis now. And so, you know, clearly our cost structure should improve as the virus gets less and less and we have less impact on our accruing and so forth. It's just gotten to the point where it's part of our normal operations of our business and embedded in our costs. So we're not breaking that out.

That makes sense. And then in terms of the gross margin pressures in the quarter, you had capacity utilization as well as this aged potato crop that had larger storage costs associated with it. I guess, which one of those was larger, and will we continue to see the headwind of the elevated storage costs on your potato inventory, or are we through with that?

Yes. In terms of the storage cost, that was just the carryover from old crop. We got through the manufacture of that crop in the first and early part of the second quarter, and so it was sitting in inventory and then sold, and we're out of that now in the second quarter. So we shouldn't see that as a headwind going forward.

Okay, and I guess just one more if I can sneak it in. Last time you gave us an update on a leveraged target, it was three to four times. Is that still the range?

Yeah, we haven't changed our leveraged targets at all. Great. I'll pass to others. Thank you.

And we can now take our next question from Carolette Casella of J.P. Morgan. Please go ahead.

Hi. Most of my questions have been answered, but I guess given some of the weakness you're seeing, is your ability to pick up new contracts or new business, has that changed? You talked about some of the competition on the lower end and the contracts for the private, but I guess that sounds like it's more your existing. Can you talk about new businesses and the opportunities there?

Yeah.

This is Tom. The team, we're always talking to potential new customers. Obviously, with the demand change, those are more difficult. A lot of the customers that we have and talk to is Initially, it was about assured supply. So, you know, kind of we got all that settled down as we got through the pandemic. And, you know, our team, our sales team are on the ground searching for new opportunities.

And that really hasn't changed from a market standpoint. Okay, great. Thanks a lot.

And this concludes the Q&A session. Mr. Comble, I would like to hand the call back to you now for any additional or closing remarks.

Thank you all for joining our second quarter call. If you want to set up a follow-up session, please pass me an email and we can get that scheduled.

But again, thanks for joining us and have a good day.

This concludes today's call. Thank you for your participation. You may now disconnect.