Lamb Weston Holdings, Inc.

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

Good morning and thank you for joining us for Lamb Weston's third quarter 2021 earnings call. This morning, we issued our earnings press 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 McNutt, our Chief Financial Officer. Tom will provide an overview of the current operating environment and our recently announced investment in China, while Rob will provide some details on our third quarter results, as well as some shipment trends for the fourth 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 sales volumes in the third quarter as restaurant traffic and consumer demand improved as governments gradually eased social and on-premise dining restrictions in some markets. While still down year-over-year, the rate of volume decline improved sequentially in both the U.S. and in our key international markets from what we realized during the first half of our physical year. Again, this was largely in response to government's easing restrictions as the quarter progressed and demonstrates that consumers are ready to go out as restaurants expand dining capacity. Specifically, overall restaurant traffic in the U.S. was between 85 and 90 percent of pre-pandemic levels. Traffic at large quick-service chain restaurants continued at roughly prior-year levels as they leveraged drive-through, take-out, and delivery formats. After a slow start to the quarter, traffic at full-service restaurants recovered to 70% to 80% of prior year levels. Traffic began to pick up later in the quarter as some governments gradually lifted social and dining restrictions that were put in place due to the resurgence of COVID. And as a relatively mild winter weather provided more outdoor dining opportunities. While we expect this momentum will continue, we're mindful that some of this performance may be due to customers and distributors restocking inventories prior to an expected boom in restaurant traffic in coming months. In contrast, demand at non-commercial customers, which includes lodging and hospitality, healthcare, schools and university, sports and entertainment, and workplace environments, remain around 50% of prior levels for the entire quarter. We're confident that demand from these customers will return, but realize that recovery to pre-pandemic levels may take some time as governments slowly lift restrictions for larger gatherings. In retail, demand in the quarter was strong, with weekly category volume at 115% to 125% of prior year levels as consumers continue to eat more meals at home. Outside the U.S., restaurant traffic and fry demand has been mixed. In Europe, which is served by our Lamb, West, and Meyer joint venture, fry demand in the quarter was 80% to 85% of prior year levels. However, we believe that demand rate is likely to soften as governments reimpose severe social restrictions in response to the resurgence of COVID infections. Demand in most of our international markets in Asia, Oceania, and Latin America improved in the quarter. Our shipments in China were strong. Demand in our other key markets, in the aggregate, remain below prior year levels, but continue to improve sequentially versus the first half of the year, as well as in each month of the quarter. So while demand in Europe remains soft, we feel good about the demand trends in the U.S. and most of our key international markets, and we expect governments will continue to gradually roll back social restrictions in the months ahead as more of their citizens get access to vaccines. This should serve to unlock pent-up consumer demand to visit restaurants and other food service outlets and ultimately demand for fries. As a result, we remain optimistic that overall frozen potato demand will steadily approach pre-pandemic levels on a run rate basis by the end of calendar 2021. The progress we made on sales volume in the quarter was offset by the pandemic's continued effect on our supply chain operations. As Rob will discuss later, COVID-related disruptions significantly affected our production, transportation, and warehousing networks, leading to significantly higher costs as we focused on customer service while dealing with the pandemic's impact in some of our communities and workforce. In addition, decisions that we made in the first half of the year to defer certain capital repair and maintenance projects further reduced our flexibility to manage disruptions and drove incremental manufacturing and distribution costs. So in summary, in the third quarter, we delivered solid top-line results. Operating in a pandemic environment has been and will continue to be challenged, and we expect it will continue to incur higher costs across our supply chain in the near term. Before I turn the call over to Rob, let me review a couple of items. First, we'll provide our normal update for this year's potato crop when we report earnings in July and October. Second, as you may have seen a couple of weeks ago, we announced that we're building a new French fry processing facility in China at a total investment of around $250 million. This green-filled facility will complement our plant, Chengdu, and is expected to add about 250 million pounds of frozen potato product capacity. We anticipate starting up the plant sometime during the back half of calendar 2023. We chose to build this plant in China because it's a fast-growing 1 billion pound plus market and a key driver to our international growth. This new plant enables us to support customers in China using in-country supply, which is something that our larger customers there increasingly want as they continue to expand. In addition, our new facility will allow us to further diversify our manufacturing base and mitigate risks of potential trade disruptions as we look to drive international growth. So, in summary, in the third quarter, we delivered solid top-line results as demand continued to gradually recover, but incremental costs related to pandemic-related disruptions pressured earnings. We expect that the increasing availability of COVID vaccines and the easing of government-imposed social restrictions will allow restaurant traffic to gradually improve as the year progresses. And we remain optimistic that overall frozen potato demand will approach pre-pandemic levels on a run rate basis by the end of calendar 2021. Now let me turn the call over to Rob. Thanks, Tom. Good morning, everyone. As Tom noted, in the third quarter, we delivered solid sales results as overall demand continued to improve, but the pandemic's disruptive impact on our manufacturing and distribution operations significantly increased our costs. Specifically in the quarter, net sales declined 4% to $896 million. Sales volume was down 6%, largely due to the pandemic's impact on fry demand, but improved through the quarter after a slow start. Importantly, that rate of volume decline improved sequentially from the 14% decline that we realized during the first half of fiscal 2021. Most of the sequential improvement was within our global segment and largely reflects a steady recovery in shipments in our key international markets. Stronger sales of limited-time offering products in the U.S. also contributed to the global segment's recovery. In addition, we saw a sequential improvement in our food service segment led by casual dining, as well as continued strength by our branded offerings in our retail segment. Price mix increased 2%. Improved price in our retail and food service segments, as well as favorable mix in retail, drove the increase. Price was up in our global segment, although this was offset by negative mix. Gross profit declined $54 million as lower sales and higher manufacturing and distribution costs more than offset the benefit of favorable price mix and productivity savings. Let's focus on cost of goods sold. As Tom noted, the higher costs were largely a result of the pandemic's disruptive impact across our supply chain. The resurgence of COVID in many of the communities where our plants are located greatly affected our manufacturing workforce. At times, the combination of infected and quarantined employees significantly affected our ability to staff production lines and other key roles at a number of our facilities. The consequences were, first, we lost days of production, which resulted in a number of our plants operating well below normal utilization rates and reduced our ability to cover fixed overhead costs. In addition, Recall that a year ago, we decided to continue paying employees despite production lines being down due to COVID. While we believe that was the right thing to do to support our production teams, it has had an impact on our cost structure. Second, focusing on maintaining customer service levels required us to quickly adjust production schedules to accommodate workforce and manufacturing line availability. This drove incremental costs and inefficiencies. In many cases, we shifted production from one facility to another, even though the alternate facility may not be the most effective in terms of cost or throughput for that specific product. That negatively impacted line speeds, throughput, and raw potato recovery rates. And third, the number of effective employees and facilities meant that we incurred even more costs related to temporary shutdown and restart of manufacturing facilities. Compounding these disruptions in the quarters were our decisions to defer certain capital repair and maintenance projects on our production lines that were originally scheduled for the first half of fiscal 2021. We'd planned on undertaking these capital and maintenance projects once the demand environment and our operations were more stable during the second half of the year. While deferring these projects was prudent in light of the uncertainty surrounding COVID, Executing them that same time as another COVID wave impacted our plants led to additional disruption in our manufacturing capabilities and further limited our flexibility to adjust production schedules across our network. This drove additional costs and inefficiencies on top of the staffing-related issues I described. The pandemic-induced volatility of our production facilities also had a downstream impact on our transportation and warehousing operations. We generally prefer to rely on rail more than trucking to move product from our production facilities and warehouses to our distribution centers and customers across the country. However, late changes to production schedules required us to switch significant volume from rail to trucking. which is more flexible but also higher cost in an effort to maintain customer service levels. In addition, we typically employ trucks using contracted carrier rates as opposed to securing spot trucking, which tends to be higher cost. Spot trucking has also had significant rate increases over the past six months, but because of the disruption to our production schedules and, again, to prioritize customer service, we lean more on expensive spot trucking. So our transportation costs significantly increased because of an unfavorable mix of rail and trucking, as well as an unfavorable mix of contracted and spot trucking. As you would expect, our warehousing costs also increased with the additional handling required across our distribution network. Finally, while the pandemic-related effects on our supply chain were the primary drivers of our cost increases, We also realize higher costs due to input cost inflation in the low single digits. We expect that rate will begin to tick up in the coming quarters as edible oil and transportation costs continue to increase. While our costs were higher in the quarter, we are starting to see the benefits of our supply chain teams work around a series of initiatives we call Win as One. These initiatives build upon the land west and operating culture productivity programs that we have in place. Broadly speaking, Win as One seeks ways to reduce our variable and fixed cost, increase production throughput on existing assets, and improve working capital, especially inventories. In the couple of the plants where the team has implemented these new ways of working, asset utilization is at or above pre-pandemic utilization rates. and we're seeing the benefit in the cost structures in those facilities. As the team continues to roll out these programs to the rest of the network, and as infection and quarantine rates decline through vaccination programs we're supporting for our production employees, we expect our cost structure and utilization rates will begin to normalize. Longer term, we expect these initiatives to enhance margins, drive cash flow, and strengthen our culture of continuous improvement. Since we only began to roll out Win as One at a couple of our plants a few months ago, we're not providing any specifics on activities or targets today. We anticipate giving investors more insight into this program as we gain more traction. Moving to the segments, moving on from cost of sales, excuse me, our SG&A increased $8 million in the quarter. The increase was largely due to investments we're making behind the Win as One initiatives I just described. Equity method earnings were $11 million. Excluding the impact of unrealized mark-to-market adjustments and a comparability item in the prior year quarter, equity earnings declined about $11 million. Two factors drove the decline. First, fry demand in Europe fell as much as the region remained in lockdown and as colder weather affected outdoor dining. Second, our joint ventures also realized higher production costs related to COVID disrupting their manufacturing and distribution operations. Adjusted EBITDA, including joint ventures, was $167 million, which is down $61 million. Lower income from operations drove the decline. Adjusted diluted EPS in the quarter was 45 cents, which is down 32 cents. mostly due to lower income from operations. EPS was also down due to higher interest expense reflecting our higher average total debt, resulting from actions we took in late fiscal 2020 and early fiscal 2021 to enhance our liquidity position. Now 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 2% in the quarter. Volume was down only 2%, which is much better than the minus 12% we realized during the first half of fiscal 2021. Shipments to large chain restaurant customers in the U.S., of which approximately 85% are to QSRs, increased nominally versus prior year. QSRs continued to perform well as they continued to leverage drive-through and delivery formats. As I mentioned earlier, US QSRs were also aided by the return of some noteworthy limited-time product offerings. International shipments, which historically comprise about 40% of the segment's volume, were about 95% of prior year levels in the aggregate. That's up from around 75% of prior year levels that we realized during the first half of fiscal 2021. In the third quarter, shipments in China were strong versus a prior year when demand was negatively impacted by COVID. Shipments to our other key markets strengthened as the quarter progressed and were generally stronger in developed markets than emerging ones. Price mix was flat, with positive price offset by unfavorable mix. Global's product contribution margin, which is gross profit less A&P expense, declined 27% to $79 million. Higher manufacturing and distribution costs, as well as 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 22%. Volume declined 24%. After a slow start, shipments to smaller chain and independent full-service and quick-service restaurants recovered to about 90% of prior year levels for the entire quarter as governments gradually eased social and indoor dining restrictions. We believe that some of the sales volume strengthening during the last few weeks of the quarter may reflect distributors restocking inventory in anticipation of more governments lifting social restrictions in the spring. However, it's difficult to gauge the extent of that benefit. In contrast, shipments to noncommercial customers remained at around 50% of prior year levels, with continued strength in healthcare more than offset by weakness in other channels such as travel, hospitality, and education. Price mix increased 2% behind the carryover pricing benefit of pricing actions we took in the second half of fiscal 2020. This was partially offset by unfavorable mix versus a prior year due to lower sales of premium products. As we've discussed in previous earnings calls, We've regained much of this business since the pandemic first struck last spring, but on a year-over-year basis, it remained a mixed headwind for the quarter. Food services product contribution margin declined 30% to $70 million. Lower sales volumes, higher manufacturing and distribution costs, and unfavorable mix drove the decline and was partially offset by favorable price. Sales for our retail segment increased 23% with volume up 13%. Sales of our branded portfolio, which include Alexia, Grown in Idaho, and licensed restaurant trademarks, were up about 45%, continuing the strong growth trend we've seen since the start of the pandemic and well above category volume growth rates that have been between 15% and 25% in the quarter. The increase in our branded volume was partially offset by the loss of certain low-margin private label volume, which will continue to be a headwind on volume through the remainder of the fiscal year. Price mix increased 10%, primarily reflecting the favorable mix benefit of selling more of our higher-margin branded products. Retail's product contribution margin increased 15% to $33 million. The increase was driven by favorable mix and was partially offset by higher manufacturing and distribution costs, as well as a $1 million increase in advertising and promotional expense. Moving to our cash flow and liquidity position, we continue to be comfortable with our liquidity position and confident in our ability to continue to generate cash. At the end of the third quarter, we had nearly $715 million of cash on hand, and our revolver was undrawn. Our total debt was more than $2.7 billion, and our net debt to EBITDA ratio was about 3.5 times. In the first three quarters of fiscal 2021, we generated nearly $375 million of cash from operations, which is down about $60 million versus last year due to lower sales and earnings. We spent $107 million in CapEx, and paid $101 million in dividends. In addition, in the third quarter, we resumed our share buyback program and bought back nearly $13 million worth of stock at an average price of just over $77 per share. Now turning to our current shipment trends. Please note that instead of providing a comparison to last fiscal year's fourth quarter, we're providing comparisons to the fourth quarter of fiscal 2019. We're doing this since fourth quarter fiscal 2020, which includes March, April, and May of 2020, includes the severe impact of government-imposed social restrictions at the beginning of the COVID pandemic. It was also the height of personal and economic uncertainty for many businesses and individuals. As such, we believe the fourth quarter of fiscal 2019 provides a more meaningful comparison for investors to understand the current condition of our business. Broadly speaking, we're optimistic about the recent restaurant traffic and shipment trends in the U.S. and many of our key international markets other than Europe. U.S. shipments in the four weeks ending March 28th were approximately 90% of levels during a similar period for the fourth quarter of fiscal 2019. In our global segment, shipments to our large QSR and full-service chain restaurant customers in the U.S. were more than 85% of fiscal 2019 levels, and we expect that rate will largely continue for the remainder of the fourth quarter. In our food service segment, shipments to our full-service restaurants, regional and small QSRs, and noncommercial customers in aggregate were approximately 90% of fiscal 2019 levels. We anticipate that shipments for these customers will largely continue at similar rate for the remainder of the fourth quarter. Shipments to non-commercial customers, which have historically comprised about 25% of this segment's volume, remain at around half of fiscal 2019 levels. We expect these shipment rates will likely remain soft for the rest of the quarter, and will likely take time to fully recover to pre-pandemic levels. In our retail segment, shipments were approximately 110% of fiscal 2019 levels, with strong volume growth of our branded products partially offset by a decline in shipments of private label products. We believe this rate may gradually decline during the remainder of the fourth quarter as consumers begin to shift purchases of fries to dining at restaurants as governments lift social restrictions. Outside the U.S., overall demand varies by market. In Europe, shipments by our Lamb, West, and Meyer joint venture were about 85% of fiscal 2019 levels. Demand has softened over the past few months as governments in some of our larger markets, such as Italy and France, reimposed stricter social restrictions to combat a resurgence in COVID infections. In addition, other than in the UK, vaccination efforts across Europe have lagged well behind rates in the US. As a result, we anticipate shipments may slow during the remainder of the fourth quarter. Shipments to our other international markets, which primarily include Asia, Oceania, and Latin America, were approximately 75% of fiscal 2019 levels in aggregate. As I discussed earlier, international shipment rates have steadily improved over the past few months, and we expect that will continue during the remainder of the fourth quarter as governments slowly ease social restrictions and as the current congestion at shipping ports begins to clear up. For those markets that are currently already operating under more lenient social restrictions, we anticipate that current shipment rates for those countries will largely remain at current levels. In short, although Europe is challenging, we believe overall shipment and restaurant trends in the U.S. and most of our international markets will remain favorable as governments continue to roll back social restrictions and vaccine becomes more widely available. These trends will keep us on a path of steady progress in restaurant traffic, which we believe will lead to overall frozen potato demand approaching pre-pandemic levels on a run rate basis by the end of calendar 2021. With respect to costs, in the fourth quarter, we expect to incur a similar level of incremental pandemic-related manufacturing distribution costs as we did in the third quarter. We experienced significant disruption in our production facilities transportation warehousing networks in January and February and this continued into March. We will realize some of the costs related to these disruptions in the fourth quarter as we ship finished goods inventory produced during these months. Now here's Tom for closing comments. Thanks Rob. Let me just quickly sum up by saying We continue to prioritize ensuring the health and safety of our employees during these challenging times by adhering to strict COVID protocols in all of our manufacturing locations and encouraging all our workers and their families to get vaccinated as soon as possible. We're confident that the near-term pandemic-related pressures on our manufacturing and distribution networks are temporary and that our cost structure will normalize once we get past COVID. In addition, we believe that the investments we're making in our supply chain will improve our cost structure over the long term. We feel good about the trends in restaurant traffic and frozen potato demand in the U.S. and most of our key international markets. and remain optimistic that overall frozen potato demand will approach pre-pandemic levels on a run rate basis by the end of calendar 2021. And finally, as shown with our investments for a new facility in China and to expand chopped and formed capacity in Idaho, we're focusing 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 all our stakeholders. Thank you for joining us today. Now we're ready to take your questions.

Thank you. If you would like to ask a question, you may signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, star 1 for questions. We'll take our first question from Andrew Lazar with Barclays.

Good morning, everybody.

Good morning, Andrew.

Hi there. I know this could be a little difficult, but I was hoping maybe you could – help us maybe quantify a little bit, if you could, some of these incremental COVID costs that I know you believe are largely transitory. And if demand ultimately returns on a run rate basis by the end of calendar year to pre-pandemic levels, I guess, would you expect these higher costs under that kind of a scenario to bleed into the beginning of fiscal 22? Is that sort of an expectation we should have at this point? Or do we think that if this steady pace of improvement in restaurant traffic continues, that it's largely more of a 4Q issue? I know I've just got to follow up.

Okay. Andrew, it's Rob. In terms of quantifying it, again, we did stop breaking that out as a specific, as we viewed it as more normal. I think we started that in Q2, I believe. But the way I would think about it is that you know what pricing has done. You know we've got modest input cost inflation. And so if you go back historically and look at margins, you know, that would give you a sense of what margins should be in a normalized X the COVID costs. And I would argue that the bulk of any margin difference there is going to be related to the COVID costs. And so I think you can back into it that way and come pretty close. In terms of leading into Q1, Again, it's going to depend on how quickly we can get people and plants vaccinated and back to normal production and operating schedules. Again, we see demand recovering, as we've said, by the end of calendar 2021 to pre-COVID levels. And so as you think about that, that tells you the operating, you know, the pull on the demand side ought to be there. And so it's back to as long as we can get people in the plants to operate the plants, we should over time get costs back to where they are. But again, that'll take some time to get people vaccinated, get them back into plants and stabilize all of that. So I anticipate that certainly into Q4, and we'll probably have some bleed over into Q1 as well.

And then this is just using back of the envelope math and then the comments, Rob, that you gave around sort of the first month trends of fiscal 4Q. Based on that, it would seem to suggest maybe sales down around 10% versus 4Q of 2019. And that's sequentially a bit better than what we saw for the two-year trends in 1Q and 2Q, but maybe not quite as much as I would have expected given reopening and vaccine rollout and everything else. And so I didn't know if the math was generally right as we've got it and if I'm you know, if I was maybe expecting the sequential improvement to be a little bit greater in 4Q than it would suggest?

Yeah, it's a great question, Andrew. And I think if you look at Q4 of 19, particularly I think in our global business, that it was a pretty strong quarter. So the comp is tough in that one. The other one, and, you know, as I mentioned, that in our food service business, We believe there's a bit of restocking going on. We'll see how that plays out through Q4 in actuality, but that's one where maybe we're taking a maybe conservative perspective on that, if that makes sense.

Great. Thanks very much. Thanks.

We'll take our next question from Brian Spillane with Bank of America.

Hey, good morning, everyone. Morning, Brian. So just a few questions for me, maybe just related to Andrew's question about the sales trends. I think in the press release, you talked about U.S. QSRs or U.S. global running, I think, at 85% of prior year. And I think that's down, right? I think it was running at 95% when you reported the second quarter. So, A, is that true? And, B, is there something in the comps or just what's happening there that would have suggested maybe – a slowdown, or is there a slowdown to get than that?

Yeah, I think that, again, that goes back to the comp back to 19, if you look at the global. And so the comp to 19, again, that Q4 19 being a particularly strong quarter in the global business unit, if you look at that. Okay. Hey, Brian. Hey, Brian.

Yeah. Hey, Brian, it's Dexter. I mean, in short, we don't see a slowdown versus, you know, if you think about it on Q3, Q4 sequential. I mean, the Q is North American businesses. It's all not well.

Okay. And then second question, just can you give us a sense of where you stand now in terms, and I don't know what the right measure is, but COVID impacting, I guess, the production, right? Whether it's absenteeism or utilization rates or, you know, it seems like it, surged and maybe a little bit more than you expected at some point during the third quarter. I'm just trying to get a sense of like current state of, you know, business. Has it improved at all or are you still pretty much the same level of absenteeism that you were experiencing in the third quarter?

Hey, Brian, it's Tom. I would say it is improving. We have taken a number of actions several weeks ago. to encourage our employees to get vaccinated. You know, but we are seeing improvement. And, you know, the thing Rob talked about in his prepared remarks, the thing that, you know, I made the decision that we're going to service our customers. So that is causing problems. As we take the plants down, like Rob said, we're moving things around, and it's very unnatural for us right now. This is not a systemic problem. This is a short-term issue that we'll continue to manage through. But we've got the right team focused on the course corrective actions that And, you know, but there is adjustments every week on production. And that's a decision. It's right for the company. It's right for the service, our customers for the long term. But it is improving. And, you know, I think as the employees and people get vaccinated and, you know, we're still following our protocols and the plans to keep the employees safe. But, you know, we are seeing improvement and it could gradually improve and And I suspect, you know, we get to summer and we should be in pretty good shape, close to normalized run rates.

All right. Thanks, Tom. Thanks, Rob.

You bet. Thank you. We'll take our next question from Chris Groh with Stievel.

Hi. Good morning.

Good morning, Chris.

Hi. Just had a question for you if I could ask first about the international performance and really focus more on the outlook performance. you'd indicated that the Europe, I guess I understand, given there's been some incremental restrictions there, but in some of those, what you call other key markets, I think about Asia and Oceania in particular, and I know Latin America would be a little weaker right now given restrictions in those markets, but to run at 75% of 4Q19 levels, I was surprised at that degree of decline or lower level of shipments. I just want to understand, you mentioned China being very strong. Are there other markets that are weighing on that, especially in that Asia region that may be, uh, resulting in this weaker performance overall?

Yeah, this is Rob. The, um, in particular, the Philippines is a little bit light, but we've also had some, some business shifts. Um, we've moved, you know, some of the business that has come through our top line historically, we've moved to land West and Meyer. Um, and so some of that's just shipped within, you know, our overall platform, uh, is part of it. But, but, uh, The other piece that just in the near term that's playing a little bit of a role is the port issues and some of the logistics challenges you've seen, you know, more globally where, you know, getting containers available and so on and so forth is having an impact. We think that'll clean up, but that's also having an impact on those volumes.

Okay. That port issue, was that an issue in the quarter or more of an issue, say, going forward, like in Q4 and going forward?

Well, it was certainly an issue in the quarter to some degree with exports. But going forward, it's not cleaned up yet. And, you know, we're in the same boat as everybody else who's exporting out of the Port of Seattle and the West Coast ports that container availability and ship reliability. So we'll see a bit of what we think into this quarter as well.

Okay. And then there were some reports recently about potato costs being down from this current crop. And I know that can vary by region and state and whatnot. I just want to get just an overall sense that we're going to get a better update on the crop conditions going forward. But can you talk at all about what's been reported, at least, that potato costs could be down a little bit from this coming crop?

Yeah, Chris, this is Tom. As I always do in July and October, Chris, I'll update you on the overall crop condition, acres, yield, all those kind of things. And I defer on the overall contract pricing as we aren't all the way closed yet. I understand that there's reports out there, but I will address that in July as I always do. Okay. Thank you for that. Yep.

Thank you. We'll take our next question from Adam Samuelson with Goldman Sachs.

Yes, thanks. Morning, everyone. Morning, Adam. Hi. So I guess I was hoping on the cost issues in the quarter, and Tom, Rob, I appreciate that it was kind of a whole cascade of things that kind of snowballed on themselves, but is there any way to disaggregate some of the, and dimensionalize some of those individual pieces in terms of the incremental freight expense, kind of unplanned downtime, fixed costs under absorption. I'm just trying to make sure we're sensitive to kind of how those really impacted the margin performance. And again, where some of that might continue into the upcoming quarter, we can be sensitive to layering in that impact and then taking that impact out as we get into fiscal 22 and 23.

Yeah, I think it's, it's, I mean, obviously we've got the data internally, but I don't want to start down a path of disaggregating that and have an update on it. But I guess what I would say is that it all stems from not being able to staff and operate those lines because of COVID. And so it's that cascading effect. And so there's nothing... systemic in the operating costs there that I would call out. It's really that one time or the temporary impact of the COVID. On the transportation side, again, you know, the the shifting around from rail to truck and more spot trucking and so forth, that's temporary as well, driven off of that same issue. But I would point that there is generally transportation cost inflation going on. And so as we go recontract freight, you know, for the coming periods, I think we, like everybody else, are going to see freight cost increase.

Hey, Adam, it's Spencer. You know, Yeah, we have tried to step back from giving out on specific numbers. You know, of course, we've got the data internally, but it's just one of those things that, you know, how much is really specific to COVID and things like inflation that might not be. So we're just trying to be careful in terms of, you know, doing that and trying to report that kind of going forward because it isn't in precise science at the end of the day. But, you know, we gave you the three biggest drivers plus inflation on our COGS. So, you know, it's tough to give you a sense of how much is specific to each individual item. So sorry about that.

Okay. All right. Maybe I'll circle back with that one. Follow-up question was really on the new China plant and just – thinking about both timing and market impact. Do you think as we look at that when it comes online, is there sufficient market growth in China that that wouldn't actually need to displace imports and that the market growth domestically there could absorb that while the import number stays roughly the same? Or how do you think about the knock-on effects of the China plant in terms of very important needs and how that would cascade back to the U.S. Thanks.

Yeah, I'd admit it absolutely fits into our long-term strategic plan. China is a big market. It's a billion, billion one pound. It's been growing at 10 to 15 percent annually for a number of years. We expect that growth to continue. You know, a lot of the bigger Our bigger customers are expanding their storefronts and continue to do so. And, you know, the plant's going to take about two years to come online. And, you know, Adam, it gives us flexibility to shift current export production to in-country, which is another strategic reason to build that plant. And we're committed to China and we'll be committed to it long-term. But it, again, adds geographical flexibility to our overall operating network around the globe, but it's two years out. So these things, you've got to think through what the category is going to look like in two years in some of these markets, and you've got to invest in it. And that's part of one of our strategic pillars is to continue to invest in this company for the long term, and we'll continue to do that.

Okay, great. I'll pass it on. Thanks.

Thanks, Jen.

We'll take our next question from Tom Palmer with JP Morgan.

Good morning, and thanks for the questions. Good morning. I appreciate that it's tough to be overly precise, but I wanted to ask about your segment mix expectations. You noted that volume could be back to pre-pandemic levels by the end of the calendar year. How are you thinking about the mix between global and food service? Based on what you're seeing from customers, do you think that both segments could approach pre-pandemic volumes, or should we be thinking about a shift towards the global side?

Yeah, this is Tom. I expect, you know, at the end of the calendar year, based on, you know, some of the data we look at, things we're projecting, you know, food service to be back to pre-pandemic levels. And, you know, it's as As we've seen markets in the U.S., not all of them open up and just lift restrictions. We've seen them approach or get pretty darn close to pre-pandemic levels. Now, we need some time to work through overall the consumer behavior of going back to eat at restaurants over a longer period of time. But that gives me confidence that there's some pent-up demand for the restaurants in our food service segment. And I think we'll get back to, we'll get back to pre pandemic levels by the end of calendar year. And, and, you know, the mix will, um, settle into where it was before all this happened in terms of segment.

Okay. Thanks for that. Uh, really helpful. Um, and then I had kind of a different type of mix. Um, so you, you noted mixed headwinds from a pricing standpoint in both global and food service during the third quarter. Um, we're lapping some pretty big mix headwinds a year ago in the fourth quarter. And here you are a month in with, with improving volume trends. Should we think about mix kind of swing to a tailwind as we think about the fourth quarter?

Yeah, I, you know, the, obviously there's going to be a significant mix change versus you know, Q4 of last year, which everybody knows we're in the deep end of the, The pandemic, you know, so the food service, we expect food service trends to improve. Globals, pretty steady state and growing to pre-pandemic levels. And, you know, retail, if you recall last year, retail directionally was up like 150%. That's going to taper off. You know, Q3 was 105 to 115 roughly. So the mix shift for us will be skewing back to, I call it a more normalized segment mix, you know, in Q4. Okay.

Thanks, guys.

Thank you. We'll take our next question from Rob Dickerson with Jeffries.

Great. Thank you so much. Just, Tom, just a question around capacity of the industry and then also your decision to obviously lean into China a little bit. And I guess combined with all the comments you were talking about today, just kind of shifting maybe some volume into some less efficient plants. Should we take the China investment kind of as a kind of go forward use of cash as you think about incremental capacity versus potentially looking at some of your footprint within the U.S. and maybe making some of those plants more modernized, so to speak, and more efficient?

In terms of China's use of cash, we're evaluating that. The way to think about our North America footprint is we've had a continual modernization program for decades. you know, five, ten years. So we're upgrading these plants with the latest technology. There's a certain amount of maintenance we do every year we're committed to for food safety and people safety and some of the bigger equipment that's aged, we replace it. And, you know, just in terms of overall capacity in the industry, you know, I think about the category two to three years out. And, you know, based on our projections on the category growth overall, that's what drives a lot of our decisions in terms of investing because we've got to make a decision now for what we think is going to happen in two, two and a half years. And that's the way we've always operated. And I think, you know, I think the category will come back by the end of the calendar year on a normalized run rate basis. And I believe it's going to return to growth. The things that we're going to do in the near term is make sure we're positioned to capture our share, capture the growth, and service our customers and continue to evaluate the footprint and the cost competitiveness of our footprint in the marketplace. That will drive the investment decisions going forward here in the next 12 to 15 months.

Got it. Okay. So, I mean, for now, obviously, it's a kind of wait and see where the growth goes in the next 12 months. It sounds like the footprint for now is good, right? There's not really a need to necessarily lean into the U.S. side with incremental capacity, but if The industry continues to grow. That's obviously a use of cash potential going forward over the next two years.

Yeah, I'll jump in. Think about it this way. We've got to think through what the next two years, two, three years of the category is going to look like. I'm not going to sit and wait and see what happens. So we're going to make some decisions and potentially move some things forward to get ourselves ready for, you know, the next two, three years so we have available capacity to meet the demand and the category growth and service our customers. Just like we have been in the past, you know, we make decisions now anticipating what two and three years is going to look like.

Yeah, fair enough. Thanks a lot. I really appreciate it.

Thank you. As a reminder, Star 1, if you'd like to ask a question. We'll take our next question from Jenna Gianelli with Goldman Sachs.

Hi there. Thanks for taking my question. I just had a follow-up one on the China plant. Did you talk or have you talked about the cadence of the CapEx spend that you're planning there? And then just in terms of impact, you know, potential efficiencies gained, anything that you can point to from maybe past examples where you've expanded capacity and the type of, you know, overall benefits from a margin standpoint that you saw? Thanks.

Yeah, Janet, we have not talked about the cadence of that CapEx spend there. Again, it's $250 million. It'll take us about two years to get it in. And, you know, again, you've got a lead time order on equipment and progress payments against that. And so I think, you know, to some degree that it's going to be the bulk of it's going to be a big chunk of the spend is going to be in next fiscal year and then following into the last several months before startup there. So some of it will be this year, but the bulk of it is going to be in next year and into the following year. In terms of efficiencies, clearly we're going to gain technical efficiencies in areas like recovery, but there are so many variables that go into that. Clearly labor costs are lower in China than they would be in the U.S., But, you know, you get some offsets and some other things. But clearly we'll gain some efficiencies there. I will tell you that the folks who have been running our existing plant in Chengdu, and we've done some debottlenecking there to service growth there, have done a great job of managing those assets and extracting the real value out of those. So we're very confident in the team there and their ability to deliver when we give them the new asset to work with.

Okay, perfect. That's super helpful. And I just have one more if I can. I know that you mentioned that you may have seen it's hard to gauge, but some pull forward of demand from your food service customers kind of in preparation for what they're expecting is more demand. So from your standpoint, how are you thinking about working capital requirements as demand ramps for you? I guess mainly in kind of the food service and to a lesser extent, but the global segment. And that's it for me. Thank you.

Yeah, I think if you think about the ramp up in that, you know, just look at the demand, look at our DSO on the receivable side and what it's been historically, and we'll ramp back up to those kinds of, you know, levels in our food service. So that's what we anticipate is it'll just get back to kind of normal DSO levels when you get to year end, and, you know, it'll carry through to the receivables number.

Thank you. We'll take our final question from Carla Casella with J.P. Morgan.

Hi. One follows on the cost question. Can you give us a sense for how much of your total COGS is feed-grade oil or edible-grade oil?

Dexter, I'm not sure if we've just – go ahead.

No, we haven't. Carla, let me take that. We don't give a specific on that, what we have said on COGS. just generally breaking down, uh, normal environment about, you know, roughly a third is raw potatoes, roughly another called 20, 25% is going to be a combination and no particular order here of edible oils, packaging and miscellaneous ingredients. And the remaining, you know, called 40, 45%, again, no particular order here, combination of fixed overhead, uh, conversion costs, which is largely labor, uh, fuel, electric power and water, and then finally transportation and warehousing. We don't break it down any finer than that.

Okay, great. That's helpful. Thank you.

That will conclude our question and answer session at this time. I'd like to turn the call back over to Mr. Congvoi for any additional closing remarks.

Hi, everybody. I appreciate the time today and listening to the call. Any follow-up questions or need to speak, best thing to do is pop me an email, then we can schedule time. But have a good day, everyone. Thank you.

That will conclude today's call. We appreciate your participation.