Lamb Weston Holdings, Inc.

Q1 2022 Earnings Conference Call

10/7/2021

spk12: and welcome to the Lamb-Weston First Quarter 2022 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Dexter Congolet, VP Investor Relations of Lamb-Weston. Please go ahead.
spk09: Good morning, and thank you for joining us for Lamb-Weston's First Quarter 2022 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 Bernadette Madriada, our Chief Financial Officer. Tom will provide some comments on our performance, as well as a brief overview of the current operating environment. Bernadette will then provide details on our first quarter results and fiscal 2022 outlook. With that, let me now turn the call over to Tom.
spk08: Thank you, Dexter. Good morning, and thank you for joining our call today. We're pleased with our strong sales growth in the quarter, which reflects the ongoing broad recovery demand across our out-of-home sales channels, as well as continued improvement in our key international markets. However, our margin improvement lags our volume recovery as a result of the timing of pricing actions to offset cost inflation, as well as challenging macro factors that increase our cost and affected our production run rates and throughput. These ongoing challenges, combined with the extreme summer's heat, negative impact on potato crops in the Pacific Northwest will result in higher costs as the year progresses. As a result, we now expect our gross profit margins will remain below pre-pandemic levels through fiscal 2022. We believe many of these costs and supply chain challenges are transitory, and we're taking aggressive actions to mitigate their effects on our operations and financial performance. We're confident that our actions, along with our investments to improve productivity and operations over the long term, will get us back on track to deliver higher margins and sustainable growth. Before Bernadette gets into some of the specifics of our first quarter results and outlook, let's briefly review the current operating environment, starting with demand. In the U.S., we continue to be encouraged by the pace of recovery in restaurant traffic and demand for fries. Overall, restaurant traffic has largely stabilized at about 5% below pre-pandemic levels, led by the continued solid performance at quick service restaurants. Traffic at full service restaurants continued to rebound in June and July, but it did soften a bit in August as the Delta variant surged across most of the country. Demand improved at non-commercial food service outlets, especially in the education market, which helped to offset the near-term slowdown in full-service restaurants. The fry attachment rate in the U.S., which is the rate at which consumers order fries when visiting a restaurant or other food service outlets, also continued to help support the recovery in demand by remaining above pre-pandemic levels. Demand in U.S. retail channels also remained solid, with overall category volumes in the quarter still up 15% to 20% from pre-pandemic levels. Outside the U.S., overall Friday demand continued to improve in the quarter, although the rate of improvement varied widely among our key international markets. Demand in Europe, which is served by our Lamb, West, and Meyer joint venture, gradually recovered as vaccination rates climbed. Demand in Asia and Oceania was solid, but also softened in August due to the spread of the Delta variant, and South America remained challenged, especially in Brazil. So overall, we're happy with the recovery in global demand and believe it provides a solid foundation for continued volume growth in fiscal 2022. With respect to the pricing environment, I'm pleased with the progress of our recently implemented pricing actions to manage sharp input cost inflation. In our food service and retail segments, as well as in some of our international business, we'll begin to realize some of the pricing benefits in the second quarter and more fully in the third quarter. In our global segment, the contract renewables for large chain restaurant customers have largely progressed as we expected, and we'll generally begin to see the impact of any pricing actions associated with these contracts in our third quarter. In addition, we'll continue to benefit from price escalators for most of the global contracts that are not up for renewal this year. These price adjustments reset based on the underlying timing of the contract renewals, but largely during our physical third quarter. Overall, we expect our price increases across our business segments will, in aggregate, mitigate most of the cost inflation. However, depending on the pace and scope of inflation and the increase in potato costs resulting from this year's poor crop, we may take further price action as the year progresses. In contrast to demand and pricing, the manufacturing and distribution environment continues to be difficult. Our supply chain costs on a per pound basis have increased significantly due to input and transportation cost inflation, as well as labor availability and other macro supply chain disruptions that are continuing to cause production inefficiencies across our global manufacturing network. Although we're making gradual progress to mitigate these challenges, they have slowed our efforts to stabilize our manufacturing operations during the first half of fiscal 2022. As a result, we expect the turnaround in our supply chain will take longer than we initially anticipated. Now turning to the crop, the early read on this year's crop in the Columbia Basin, Idaho, and Alberta indicates that it will be well below average levels in both yield and quality due to the extreme heat over the summer. As we're still in the middle of the main crop harvest, the extent of the financial impact of the crop condition will be determined over the coming quarter as the harvest is completed. While we expect this impact will be significant, we're examining a variety of levers to mitigate the effect on our earnings as well as on customer service and supply. As usual, we'll provide a more complete assessment of the crop and its impact on earnings when we release our second quarter results in early January. So, in summary, I feel good about the overall pace of recovery in French fry demand, especially in the U.S. I believe it provides a solid foundation for future growth. I also feel good about the current pricing environment and how we're executing pricing actions in the marketplace. We do expect higher potato costs, input in transportation inflation, labor challenges, and other industry-wide operational headwinds to continue for the remainder of this fiscal year. While we're taking specific actions to mitigate these challenges, they will keep our gross margins below pre-pandemic levels through fiscal 2022. And finally, I'm confident that we're taking the right steps to get our company back on track to delivering more normalized profit margins. Let me now turn the call over to Bernadette to review the details of our first quarter results in our physical 2022 outlet.
spk00: Thanks, Tom, and good morning, everyone. As many of you know, this is my first earnings call as CFO of Lamb Weston. I've now been in the role for about nine weeks. For those on the line that I haven't met, it's a pleasure to meet you over the phone. I'm looking forward to meeting many of you in person over the coming months as we get back into the cadence of in-person investor meetings and industry events. As Tom discussed, we feel good about the health of the category and our top-line performance in the first quarter and expect our gross margins going forward will improve as we benefit from our recent pricing actions, as well as from other actions that we're taking to mitigate some of the macro challenges affecting our supply chain. Specifically, in the quarter, sales increased 13% to $984 million, with volume up 11% and price mix up 2%. As expected, volume was the primary driver of sales growth, reflecting the ongoing recovery in fry demand outside the home in the U.S. and in some of our key international markets, as well as a comparison to relatively soft shipments in the prior year quarter. Lower retail segment sales volume partially offset this growth, largely as a result of incremental losses of low margin private label business. Overall, our sales volume in the first quarter was about 95% of what it was during the first quarter of fiscal 2020 before the pandemic impacted demand. Moving to pricing. Pricing actions and favorable mix drove an increase in price mix in each of our core business segments. As I'll discuss in more detail later, our pricing actions include the benefit of higher prices charged to customers for product delivery in an effort to pass through rising freight costs. The offset to this is higher transportation costs and cost of goods sold. Gross profit in the quarter declined $63 million. as the benefit of higher sales was more than offset by higher manufacturing and transportation costs on a per-pound basis. The decline in gross profit also includes a $6 million decrease in unrealized mark-to-market adjustments, which includes a $1 million gain in the current quarter compared with a $7 million gain in the prior year quarter. The increase in cost per pound primarily related to three factors. First, We incurred double-digit cost inflation for key commodity inputs, most notably edible oils, which have more than doubled versus the prior year quarter. Other inputs that saw significant inflation include ingredients such as wheat and starches used to make batter and other coatings, and container board and plastic film for packaging. Higher labor costs were also a factor as we incurred more expense from increased unplanned overtime. Second, our transportation costs increased due to rising freight rates as global logistics networks continue to struggle. Our costs also rose due to an unfavorable mix of higher cost trucking versus rail as we took extraordinary steps to deliver product to our customers. Together, inflation for commodity inputs and transportation accounted for approximately three-quarters of the increase in our cost per pound. The third factor driving the increase in cost per pound was lower production run rates and throughput at our plants, from lost production days and unplanned downtimes. This resulted in incremental costs and inefficiencies. Some of this is attributable to ongoing upstream supply chain disruptions, including the timely delivery of key inputs and other vendor-supplied materials and services. However, most of the impact on run rates was attributable to volatile labor availability and shortages across our manufacturing network. So what are we doing to mitigate these higher costs and stabilize our supply chain? First, price. We're executing our recently announced price increases across each of our business segments, and implementation of these pricing actions are on track. Our price-cost relationship will progressively improve as our pass-through pricing catches up with the inflationary cost increases. We'll begin to see some benefit from these actions in the second quarter, and it will continue to build through the year. If needed, we will implement additional rounds of price increases to mitigate the impact of further cost inflation. We've also increased the freight rates that we charge customers to recover the cost of product delivery, and we are adjusting them more frequently to better reflect changes to the market rates. These adjustments have also lagged the cost increases. While we saw some benefit in the first quarter, we expect to see more of a benefit beginning in the second quarter. In addition, we're significantly restricting the use of higher cost spot rate trucking. Second, we're optimizing our portfolio. We're eliminating underperforming SKUs to drive savings through simplification in terms of procurement, production, inventory management, and distribution. We're also partnering with our customers to modify product specifications without compromising food safety and quality. These modifications will help mitigate the impact of lower potato crop yields from this year's crop, as well as some of the impact of reduced potato utilization that results from poor raw potato quality. Third, we're increasing productivity savings with our Win as One program. While realized savings to date have been small, given that the initiative is still fairly new, we began to execute specific cost reduction programs around procurement, commodity utilization, manufacturing waste, inventory management, and logistics, as well as programs to improve demand planning and throughput. We expect savings from these and other productivity programs will steadily build as our supply chain stabilizes. And finally, we're managing labor availability and volatility. This includes changing how we schedule our labor crews, which provides our employees more control and predictability over their personal schedules and reduces unplanned overtime. We're also reviewing compensation levels to make sure we remain an employer of choice in each of our local communities. This is in addition to the other recruiting tools and incentives, such as signing and retention bonuses. Moving on from cost of sales, our SG&A increased $13 million in the quarter. This increase was largely driven by three factors. First, it reflects the investments we're making behind information technology, commercial, and supply chain productivity initiatives that should improve our operations over the long term. About $4 million this quarter represents non-recurring ERP-related expenses. Second, it reflects higher compensation and benefits expense. And third, it includes an additional $3 million of advertising and promotional support behind the launch of new branded items in our retail segment. This increase compares to a low base in the prior year when we significantly reduced A&P activities at the onset of the pandemic. Diluted earnings per share in the first quarter was 20 cents, down from 61 cents in the prior year, while adjusted EBITDA, including joint ventures, was $123 million, down from 202 million. Moving to our segments. Sales for our global segment were up 12% in the quarter, with volume up 10% and price mix up 2%. Overall, the segment's total shipments are trending above pre-pandemic levels due to strength in our North American chain restaurant business, especially at QSRs. Our international shipments in the quarter also approached pre-pandemic levels, despite congestion at West Coast ports and the worldwide shipping container shortage continuing to disrupt our exports, as well as softening demand in Asia due to the spread of the Delta variant. The 2% increase in price mix reflected the benefit of higher prices charged for freight, inflation-driven price escalators, and favorable customer mix. Global's product contribution margin, which is gross profit less advertising and promotional expenses, declined 45% to $43 million. Input and transportation cost inflation, as well as higher manufacturing costs per pound, more than offset the benefit of higher sales volume and favorable price mix. Moving to our food service segment. Sales increased 36%, with volume up 35% and price mix up 1%. The strong increase in sales volumes largely reflected the year-over-year recovery in shipments to small and regional restaurant chains and independently owned restaurants. However, Shipments to these end customers, along with restaurant traffic, slowed in August due to the surge of the Delta variant across the U.S. Volume growth in August was also tempered by the inability to service full customer demand due to lower production run rates and throughput at our plants, largely due to labor availability. Our shipments to noncommercial customers improved through the quarter, as the education, lodging, and entertainment channels continued to strengthen. Overall, noncommercial shipments were up sequentially to 75% to 80% of pre-pandemic levels, from about 65% during the fourth quarter of fiscal 2021. The increase in price mix largely reflected pricing actions, including the benefit of higher prices charged for freight. Food services product contribution margin rose 12% to $96 million. Higher sales volumes and favorable price mix more than offset input and transportation cost inflation, as well as higher manufacturing cost per pound. Moving to our retail segment. Sales declined 14%, with volume down 15% and price mix up 1%. The sales volume decline largely reflects lower shipments of private label products, resulting from incremental losses of certain low-margin business. Sales of branded products were down slightly from a strong prior year quarter that benefited from very high in-home consumption demand due to the pandemic, but remain well above pre-pandemic levels. The increase in price mix was largely driven by favorable price, including higher prices charged for freight. Retail's product contribution margin declined 59% to $15 million. Input in transportation cost inflation, higher manufacturing cost per pound, lower sales volumes, and a $2 million increase in AMP expenses to support the launch of new products drove the decline. Let's move to our cash flow and liquidity position. In the first quarter, we generated more than $160 million of cash from operations. That's down about $90 million versus the prior year quarter, due primarily to lower earnings. We spent nearly $80 million in capital expenditures and paid $34 million in dividends. We also bought back nearly $26 million worth of stock, or about double what we have typically repurchased in prior quarters. During the quarter, we amended our revolver to increase its capacity from $750 million to $1 billion and extended its maturity date to August 2026. At the end of the first quarter, our revolver was undrawn and we had nearly $790 million of cash on hand. Our total debt was about $2.75 billion and our net debt to EBITDA, including joint ventures ratio, was 2.7 times. Now let's turn to our updated outlook. We continue to expect our sales growth in fiscal 2022 to be above our long-term target of low to mid-single digits. In the second quarter, we continue to anticipate sales growth will be largely driven by higher volume, as we lap a comparison to relatively soft shipments during the second quarter of fiscal 2021 due to the pandemic. We expect price mix will be up sequentially versus the 2% that we delivered in Q1 as the execution of pricing actions in all of our segments remain on track. For the second half of the year, we continue to expect our sales growth will reflect more of a balance of higher volume and improved price mix as we begin to lap some of the softer volume comparisons from the prior year and as the benefit from our earlier pricing actions continue to build. Our volume growth, however, may be tempered by global logistics disruptions and container shortages that affect both domestic and export shipments. It may also be tempered by lower factory production due to macro industry and labor challenges as well as a poor quality crop. With respect to earnings, we expect net income and adjusted EBITDA, including joint ventures, will continue to be pressured through fiscal 2022. That's a change from our previous expectation of earnings gradually approaching pre-pandemic levels in the second half of the year. Driving most of this change is our expectation of significantly higher potato costs, resulting from poor yield and quality of the crops in our growing regions. We previously assumed a potato crop that approached historical averages. Outside of raw potatoes, we expect double-digit inflation for key production inputs, such as edible oils, transportation and packaging, to continue through fiscal 2022. We had previously assumed these costs would begin to gradually ease during the second half of the year. We also expect the macro challenges that have slowed the turnaround in our supply chain to continue through fiscal 2022. That said, we expect the labor and transportation actions that I described earlier, along with our Win as One productivity initiatives, will help us continue to gradually stabilize operations, improve production run rates and throughput, and manage costs as the year progresses. For the full year, we expect our gross margin may be at least five to eight points below our normalized annual margin rate of 25 to 26 percent. While we recognize this is a wide range, it reflects the volatility and high degree of uncertainty regarding the cost pressures that I've discussed. Consistent with prior years, we'll have a better understanding of the crop's financial impact in the next couple of months, and we will provide an update when we release our second quarter results in early January. Below growth margin, we expect our quarterly SG&A expense will be in the high 90s. as we continue our investments to improve our operations over the long term, while equity earnings will likely remain pressured due to input cost inflation and higher manufacturing costs both in Europe and the U.S. We've also updated a couple of our other targets for the year. First, we've reduced our capital expenditure estimate to $450 million from our previous estimate of $650 to $700 million. This significant reduction is due to the timing of spend behind our large capital projects and effectively shifts the spend into early 2023, fiscal 2023. Despite the shift in expenditures, our expansion projects in Idaho and China remain on track to open in the spring and fall of 2023, respectively. And second, we're reducing our estimated full-year effective tax rate to approximately 22%, down from our previous estimate of between 23 and 24%. Our estimates for total interest expense of around $115 million and total depreciation and amortization expense of approximately $190 million remain unchanged. So in summary, the strong recovery in demand helped fuel our top-line growth in the first quarter, but higher manufacturing and distribution costs led to lower earnings. For fiscal 2022, we expect net sales growth will be above our long-term target of low to mid-single digits, but that our earnings will continue to be pressured for the remainder of the year due to higher potato costs from a poor crop and persistent inflationary and macro challenges. Nonetheless, we expect to begin to see earnings improve in the second quarter behind our pricing actions and the steps we're taking to improve our costs. Now, here's Tom for some closing comments.
spk08: Thanks, Bernadette. Let me just sum it up. We feel good about the near-term recovery and demand in the U.S. and our key international markets, as well as the long-term health and growth of the category. We're taking the necessary steps with respect to pricing and continuing to focus on stabilizing our supply chain to mitigate near-term operational headwinds and improve profitability. We're on track with our recently announced capacity investments to support our customer and category growth, as well as our long-term strategic and financial objectives. Thank you for joining us today. Now we're ready to take your questions.
spk12: And if you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question. Let's take our first question from Tom Palmer with J.P. Morgan.
spk11: Good morning, and thank you for the question. Good morning, Tom. I guess just to kick off, maybe ask on the pricing side, I know your initial round is just starting to work its way through the market, but it sounds like it's not going to fully offset inflation. Could you maybe talk about at what point, just from a timing standpoint, you could think about that second round being instituted? And then to what extent do you think you'll be able to price for potato inflation? I know that your sourcing is maybe a little bit different than what the broader U.S. might be facing this year in terms of potato costs. So just trying to kind of understand that pricing dynamic. Thanks.
spk08: Yeah, so the pricing – this is Tom Warner – the pricing generally we have priced through to offset inflation across the portfolio. It's a matter of timing. Um, so as we've stated, we'll start realizing some of that here in Q2, but the, the full impact, um, of our pricing actions across our segments, we'll start to realize in Q3 and that's pretty typical, uh, in previous years. And, and, you know, one of the things, um, that impacted this quarter is we got behind on it, quite frankly. So we're catching up. And as we evaluate the go forward, you know, we're closer to it. We're taking a number of different actions, particularly in our freight area to pass those costs through based on freight availability and, you know, managing customer service. So, you know, we've adjusted. And we'll evaluate it going forward and determine based on how inflation is coming at us, we'll react a lot quicker.
spk11: Okay, thanks for that. And then I know this is a small segment, but it actually was, I guess, a meaningful margin overhang this quarter. The other segment swinging to a loss despite mark-to-market gains. What drove that this quarter? Is that something we should expect to recur, or was it kind of an unusual item?
spk09: Hey, Tom, it's Dexter. You had a sizable gain, I think, last year in mark-to-market, and that flows through other, and the gain in mark-to-market this year is smaller.
spk11: Okay, yeah, I mean, even excluding that, I think you're looking at around a $15 million decline year over year.
spk09: Oh, no, no, no, no. I'd have to look that up again, but it's not that. It's much more than that. I mean, the details on that will come out in the K offhand, but we'll circle back on this call to give you the answer on that, but we'll just look it up real quick.
spk03: Okay, thanks.
spk12: We'll take our next question from Adam Samuelson with Goldman Sachs.
spk06: Yes, thank you. Good morning, everyone.
spk00: Morning. Morning.
spk06: Morning. I was first hoping to ask on some of the gross margin commentary, Bernadette, that you just gave in your prepared script. The 2022 gross margins coming in 500 to 800 basis points below your normalized range. And I know that there was expectations that the first half of the fiscal year would have lower gross margins than the second half when you reported back in July. So I'm just trying to get a sense of how much that has actually changed and what the increment or the decrement to the outlook is this year on margins and specifically in terms of how that outlook has changed, how much is the potato crop at this point?
spk00: Thanks for your question. The five to eight basis points that we referenced, a lot of that is due to the potato crop. The things that I mentioned that has changed is we've got a worse potato crop than we've seen in many years. So there's a couple of things that we're doing, as I mentioned, in terms of skew rationalization and, you know, the product spec changes that we're doing that we're hoping to offset some of that impact on costs. But most of that is related to a poor crop. And then the other thing that I mentioned is that we had previously anticipated the inflation would gradually ease. and we no longer expect that. We've given the guidance of five to eight points, but we will come back in January and we'll update that further depending on what we learn more about the crop as we typically have done.
spk06: Just to be clear, because there wasn't a similar kind of margin number framed back in July, how much did it change versus the outlook in July?
spk00: Well, I think the outlook in July, we said we were approaching our normal margins, which is the 25 to 26%. And so now we're saying it's five to eight points below.
spk06: Okay. And I guess the second question is more of a conceptual one because clearly these inflationary dynamics are not easing. Is the goal not just to recover cost one for one, but actually to price for margins as well? It's a very different item if we're thinking, okay, well, unit margins on a per pound basis go back to pre-pandemic levels as opposed to percent margins in an inflationary environment go back to pre-pandemic levels. And I'm really also thinking as we go into calendar 22 and even your fiscal 23, the way some of these input markets would be shaping up, it would seem like your contract to potato costs for next year are going to be up a lot. And I'm just trying to think about conceptually, is it Is the goal to price for unit margins or is the goal to actually price for those percent margins?
spk08: Yeah, Adam, so the goal is to continue to price through inflation. And, you know, at levels we historically do. So that's number one. Number two, you know, the 2022 crop, I'll comment on that as we do, as we get through negotiations. on how that's shaping out for the next crop year. The thing I just want to remind everybody is we're dealing with a challenging crop. There's no question about it. And we'll work through it. We're focused on all the right things. The good news in this business, we get to start all over for the next crop. So we'll manage through it as best we can. We're focused on all the right things. But, you know, as things start playing out, like I said to the previous questions, we'll evaluate additional actions we need to take to price through inflation.
spk06: Okay. All right. That's helpful.
spk03: I'll pass it on. Thanks.
spk12: We'll take our next question from Rob Dickerson with Jefferies.
spk03: Thank you, Rob. Thank you so much.
spk09: Hey, Robert, can you hold off for a second? I just want to close off Tom's question on the other product margin. Year over year, reported basis down 20. Next mark to market, we're down 4. So as you can see, the biggest swings is due to the mark to market this year and last year. And from an operational basis, again, down 4 million. That's due to higher manufacturing costs and lower volumes in our vegetable business. Sorry, Robert.
spk07: No problem, Dexter. Great, thanks. I guess just first question, you know, it sounds like up front you said demand is kind of overall maybe around 5% lower than it was pre-pandemic, but maybe shipments are a little bit lower just kind of given all the supply chain issues. So, you know, as you then speak to, you know, trying to stabilize the supply to improve the call situation going forward. How do you kind of view that shipment piece relative to demand? Because demand seems strong. Maybe you're kind of underperforming a bit relative to that demand equation, but sounds like there's obviously a good line of sight how to get there. So I'm just kind of curious as the cadence for the year. Thanks.
spk08: Yeah, so this is Tom. The You know, the international business has been, you know, with the container shortages, challenges on the ports and the exports and even the containers coming in, you know, we're essentially allocated a certain number of containers. So we're managing to that level based on our freight partners and And, you know, every day is a little bit different. So the team's doing a good job making sure we're allocating the product, you know, to our key customers internationally. But it's a challenge. And, you know, on the flip side of that, that does, you know, as we look at our forecast weekly, you know, we're managing the pile on production and other customers domestically. to ensure they're getting their product. So it's a really dynamic situation with the containers and even the trucking and the rail and all those things. But essentially, we're managing to what we can ship based on our allocation of containers, and that's what we're dealing with. And as that frees up and we get more containers available, that'll help the exports to our international markets.
spk07: Okay, great. And then, Tom, maybe just kind of another – just a question on kind of broader competitive dynamic. You know, I've heard some people, you know, say, maybe including yourself a bit, you know, kind of given your, you know, geographic sourcing focus, that maybe you might be in, you know, less of a, you know, kind of beneficial competitive position versus some of the other larger processors. That being said, you know, I've also heard some of the other processors say kind of not so fast, just given, you know, where demand is and kind of where kind of an overall crop is coming in, that supply in general could just be short, right, not just for you. So just curious if you can provide any color, you know, basically your perspective around kind of where you stand, you know, potentially in this environment relative to some of the other players that you're aware of in the market. And then I have a quick follow-up.
spk08: Yeah, Rob, it's a fluid situation right now because we're right in the middle of main crop harvest. So obviously we're getting an early read, like I said, on how the quality and the yields are. We really won't have a clear view until the end of this month on what the overall potato yield yields what that means. We have an idea. I'd rather, as I do every year in January, give you a clear understanding. Right now, we're just learning how the main crop is going to perform as we harvest and how it's running through the plants. We'll have more info on that in January.
spk07: Okay, fair enough. Then just a quick technical question. In the food service division in Q1, you know, price mix was up 1%. Obviously, there was some material deceleration relative to what we saw in Q4, which was likely very mix-driven. So just any clarity as to kind of how we should think about that going forward on the mix side, just given the delta Q1 – sorry, Q4 to Q1. Thanks.
spk00: Yeah, a lot of that – this is Bernadette, Rob. A lot of that is mix-driven, and then – What we see in the food service side is we're not going to see a lot of those pricing increases effective until second quarter and then more in third quarter, as we discussed. But, you know, then again, too, we are seeing increases in our noncommercial segment in first quarter relative to fourth quarter. We're now, you know, 70% to 80% there. So a lot of it's mixed.
spk07: Okay. Got it.
spk00: Thank you. Branded products.
spk09: And then last year Q4 was such an anomaly because – That's the first quarter that was really impacted by the pandemic. And a lot of the, in fact, we sold a lot less branded product during that quarter as inventories were destocked.
spk07: Got it. Got it.
spk03: All right. Thank you so much.
spk12: And we'll go to our next question from Andrew Lazar with Barclays.
spk05: Thanks. Good morning, everybody.
spk08: Morning, Andrew.
spk05: Hi. I seem to remember at one point, having a conversation around, and correct me if I'm wrong, about back many years ago when it was like the worst potato crop anyone in the industry sort of could remember. It was sort of like a $25 million hit to EBITDA for Lamb Weston at the time. And I may be off on that, but I'm curious if there's any way, and it might be tough to do, but to dimensionalize what kind of an impact EBITDA, the you know, specifically sort of this crop is likely to have on EBITDA this year. And maybe it's just too early to do that. But do I have that data point right? And would this crop be worse than the one previously that was the worst that anybody in the industry had seen? I'm trying to get some perspective on that.
spk08: Yeah, Andrew, I think how you framed up what we talked about on the 20, the worst crop historically. 14. was 14, so your numbers around 25, 30 million are right. And secondly, Andrew, you know, it is too early to frame it up in terms of what the overall financial impact is going to be. And what I will say is it's worse. This crop is going to be worse than the previously worst crop ever. The financial impact, we'll put some guardrails around it in January as we get it harvested and we're running it through the plant and we understand what we're dealing with.
spk05: That's helpful. Thanks for that. And then I guess as we – I think a lot of us certainly knew that – you know, even from the fourth quarter call that there was going to be a lot of pressure points and sort of pain points on the cost side for a host of reasons in fiscal 22. And that it was really all about just like sequential, you know, sequential improvement as you went through the year. And obviously that'll take a little more time now. So I'm trying to think out, if we just think ahead for a minute to fiscal 23, and just maybe if you'd play out the the potential sort of puts and takes. What are the things that in theory could be more positive? Where are some of the things that maybe you still don't really have a lot of clarity on? You're clearly putting a lot of pricing through, potentially could put more through. There's always a little bit of a timing lag, but one would think that's going to certainly better help you get a lot closer to where your costs are. I'm struggling with the labor piece and Are you making progress on that? Is it just slow? And I'm trying to get a sense of some of these negatives can kind of bleed into 23. Or, you know, is there a reason that there could be a pretty dramatic bounce back in, you know, operating margin and gross margins in 23? Like, do the next three quarters give you enough time, essentially, to figure out, you know, some of these issues? Or, frankly, you know, are some of these thorny enough that they could go beyond that? Even if you don't think there's some structural reason, quote, longer term to not get back to historical margins.
spk08: Yeah, Andrew, I am 100% confident over – we don't have any structural issues in the company. And everything you're poking at, we're focused on addressing labor challenges. Bernadette made a number of references of what we're doing differently, and we're seeing progress. It's just slow going. You know, the thing that, you know, will take time is even within our supply chain and our supplier's supply chain, it's disrupting our production and driving inefficiencies in our plants that, you know, we're doing a number of things to address that as well. And from... last summer to now, it's just going to take more time. We are seeing progress. It's not as fast as any of us want. But as I think through the next three quarters, where we will be a year from now with the things we're doing in the company in terms of addressing inflation and adjusting how our supply chain, we're focused on our supply chain differently, some of the actions we're taking. And, you know, a year from now, we're in a new potato crop, and that's going to be, you know, hopefully back to average normalized levels. We will have a certain amount of probably inflation over that time that we'll address. But everything we're doing is It's going to take time, Andrew, and, you know, the category is very healthy. And, you know, so we're preparing with the number of capacity investments that we're doing right now. You know, our long-term strategy is sound. It's just we're going to be a little choppy in the near term, but the things we're doing operationally, I'm 100% confident it may take more time than any of us want. but we're addressing all the right things.
spk00: Yeah, Andrew.
spk04: Oh, yeah.
spk00: Hi, Bernadette. I was just going to add that, you know, the portfolio optimization that I talked about, that's just going to benefit us even more into fiscal 23 and then the increases in productivity, you know, around a lot of those cost reduction programs around when is one. Again, that should just continue to gain momentum into fiscal 23 as well. Great.
spk03: Thank you so much.
spk12: Our next question from Peter Galbo with Bank of America.
spk10: Hey, guys. Good morning. Thanks for taking the question. Maybe just to piggyback off of Andrew's question there, I guess, Bernadette, as we're thinking about some of the things that are within your control, some of the skew rationalization and cost savings, is there any way to kind of help us frame how much of that five to 800 basis points of normalized margin that you're losing this year, how much could that potentially make up as we start to think about a more normalized year for fiscal 23?
spk00: The way I'd answer that, Peter, is a lot of the decrease that we've explained in terms of the five to eight points, that's taking into consideration that skew rationalization and the spec modifications. The impact of the crop is what is significantly decreasing our margin estimate, and then we are looking to get some gains on that to get to the five to eight basis point decrease with the skew rationalization and product spec modifications. Otherwise, it could have been even greater without that is the way I would explain it.
spk10: Got it. Okay. No, that's helpful. And then I guess just as we're thinking about, you know, the second quarter, I think you had mentioned kind of sequential gross margin improvement. Can you just mention maybe a little bit more how you're thinking about that? And, Tom, I know you talked about, you know, on-premise or food service kind of in August being impacted by Delta, but just, you know, how did September trend? Was it materially better or worse or kind of the same? Thanks very much.
spk00: Yeah, so for second quarter and the sequential improvement that we're expecting to see there, Generally, our lowest margin quarter is our first quarter, and even though the crop is not what it has been in the previous years, we are going to get some benefits in the second quarter of running out of field and not having to move those potatoes to storage before we start running those through. And then additionally, these other actions that we're taking in terms of further skew rationalization, we're going out with our second round of those, and then the product spec changes, we're expecting to see some benefit from that and should see an increase from Q1, which again is our lowest margin quarter historically.
spk03: Thanks. And Tom, anything on September?
spk00: Oh, and the pricing. Absolutely. We'll definitely see the benefit of pricing. And I'm sorry, Peter, was there another follow-on question that I missed?
spk10: Yeah, sorry. Just on kind of food service, Tom had talked a bit about the softening in August, but just was curious if there was any early takes on September or even the first week of October.
spk09: Similar to August.
spk08: Yeah, it's pretty similar to August. I mean, it's softened a bit, but it's kind of leveled out.
spk00: Yeah, and what I'd say there, Peter, is that, you know, that food service demand is there, and we are seeing just difficulty in some respects in making sure that, you know, we can provide that product given the lower throughput that we're getting through the plants.
spk03: And the logistics.
spk02: And the logistics issues.
spk03: Great. Thanks very much.
spk12: We'll take our next question from Matt Smith with Stiefel.
spk01: Hi, thank you. I just had a question for you. In addition to the margin headwind, I believe you mentioned volume growth may be tempered by the challenges you're seeing in global logistics and supply chain disruption and the potato crop. Is that potential volume weakness reflected in your guidance calling for sales growth above your long-term targets?
spk00: Yes, that has been included.
spk01: Okay, and then is the potential impact from the potato crop, should we think of that more as a second half event as you run some older potatoes with poor quality?
spk08: Yeah, it'll definitely be in the second half. It'll start manifesting itself.
spk01: Okay, and then as a follow-up to that, can you talk about how you can mitigate the impact of that as we look forward to the first half of next year? And I'll leave it there and pass it on.
spk00: Yeah, Matt, as I referenced, you know, the way we're looking to mitigate that is with some of our product spec changes and the other things that we are doing by working with our customers.
spk03: Great. Thank you.
spk12: That concludes today's question and answer session. Mr. Congolet, I'll turn the call back to you for any additional or closing remarks.
spk09: Great, thanks for joining today. Happy to take some follow-up questions. If you would, just please send me an email and then we can schedule something for either later this week or today, later this week, or sometime next week. I appreciate the time. Thank you.
spk12: This concludes today's call. Thank you for your participation.
Disclaimer

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Q1LW 2022

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