Lamb Weston Q1 2023 Earnings Report

Lamb Weston EPS Results

• Actual EPS: $0.75
• Consensus EPS: $0.52
• Beat/Miss: Beat by +$0.23
• One Year Ago EPS: $0.20

Lamb Weston Revenue Results

• Actual Revenue: $1.13 billion
• Expected Revenue: $1.14 billion
• Beat/Miss: Missed by -$17.59 million
• YoY Revenue Growth: +14.30%

Lamb Weston Announcement Details

• Quarter: Q1 2023
• Date: 10/5/2022
• Time: Before Market Opens
• Conference Call Date: Wednesday, October 5, 2022
• Conference Call Time: 10:00AM ET

Lamb Weston (NYSE:LW) Holdings, Inc. (NYSE: LW) is a food company that produces and distributes frozen potato products. Its portfolio includes frozen french fries, potato wedges, hash browns, tater tots, mashed potatoes, sweet potato products and other specialty potato items.

The company serves restaurants, foodservice distributors, retailers and food manufacturers. Its products are sold under the Lamb Weston, Grown in Idaho and Alexia brands, as well as through private-label and customer-specific offerings. Lamb Weston also provides potato-based ingredients and solutions for commercial food producers.

Lamb Weston operates a global supply, processing and distribution network serving customers in North America, Europe, Asia and other international markets. The company was established as an independent publicly traded business in 2016 when it was separated from Conagra Brands, although its potato-processing operations have a much longer history. Its corporate headquarters are in Eagle, Idaho.

Lamb Weston Q1 2023 Earnings Call Transcript

Key Takeaways

• Strong Q1 performance: Sales grew 14%, gross margin expanded nearly 900 basis points, and adjusted EBITDA nearly doubled year-over-year.
• Full-year guidance reaffirmed: Management expects to deliver at the high end of targets with $4.7–4.8 billion in sales, $840–910 million in EBITDA, and $2.45–2.85 in adjusted EPS.
• Pricing actions effective: Price‐mix growth accelerated for the fourth consecutive quarter (up 19% in Q1) and global contract escalators will drive further benefits in H2.
• Near-term volatility: Inflation, recession risk and supply-chain disruptions are pressuring casual-dining traffic and production efficiency.
• Potato crop outlook: Yields are at the lower end of the historical average but quality remains good, and open-market purchases should keep operations on track without derailing targets.

Presentation

[Operator]

Please stand by. Good day, and welcome to the Lamb Weston First Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Dexter Congbalay. Please go ahead.

[Dexter Congbalay, VP of Investor Relations at Lamb Weston]

Good morning, and thank you for joining us for Lamb Weston's First Quarter 2023 Earnings Call. This morning, we issued our earnings free 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 Werner, our President and Chief Executive Officer, and Bernadette Madarieta, our Chief Financial Officer.

[Dexter Congbalay, VP of Investor Relations at Lamb Weston]

Tom will provide an overview of the current environment. Bernadette will then provide details on our First Quarter Results and our Fiscal 2023 outlook. With that, let me now turn the call over to Tom.

[Tom Werner, President and CEO at Lamb Weston]

Thank you, Dexter. Good morning, and thank you for joining our call today. We're pleased with our performance in the quarter. We drove strong sales growth, expanded our gross margin, and nearly doubled adjusted EBITDA, including unconsolidated joint ventures. Our results reflect our continued focus on implementing pricing actions to offset input and transportation cost inflation, driving productivity and cost-saving initiatives, increasing service levels for our customers in each of our sales channels, and supporting our people and talent. We built good operating momentum over the past few quarters by focusing on these near-term objectives, and we are confident in our ability to deliver the upper end of our sales and earnings target ranges for the year. I'm especially proud of the Lamb Weston team has continued to generate solid results in a very difficult macroeconomic environment.

[Tom Werner, President and CEO at Lamb Weston]

We expect this environment to remain challenging at least through fiscal 2023 as inflation, a growing threat of recession, and industry-wide supply chain disruptions continue to pressure demand for fries as well as our cost structure. It's no surprise that inflationary trends for food, energy, and housing have affected restaurant traffic in the U.S. over the past six months. We saw similar restaurant traffic trends during the Great Recession as consumer discretionary income came under pressure. While traffic at quick service restaurants has held up relatively well, it has come at the expense of casual dining and full-service restaurants as consumers increasingly choose less expensive options when dining away from home. In the past month or so, we've seen casual dining and full-service restaurant traffic tick up from summer lows, but traffic remains below levels achieved just prior to the war in Ukraine.

[Tom Werner, President and CEO at Lamb Weston]

Unlike traffic trends, fry demand continues to be solid when dining out. The fry attachment rate, which is the rate at which consumers order fries when visiting a restaurant or other food service outlets, remains above pre-pandemic levels. Fry demand in retail channels has also benefited as restaurant traffic slows. Overall, we expect volatility in restaurant traffic and demand trends will continue through Fiscal 2023, but history has shown that this category is resilient during economic downturns. Although we may see some category weakness in the near term, we remain confident in the long-term growth prospects of the category in the U.S. and in our key international markets.

[Tom Werner, President and CEO at Lamb Weston]

In addition, as category growth returns to historical rates, we should be well positioned to capture at least our share of growth with our investments in new processing capacity in Idaho and China, as well as our newly announced expansion in Argentina. With respect to pricing, our overall price mix growth accelerated for the fourth consecutive quarter. In our food service and retail segments, we continue to realize the carryover benefit of multiple product pricing actions that we have taken over the past 15 months and expect the benefit of these actions will continue to gradually build through the first half of Fiscal 2023. In our global segment, we made good progress in increasing price mix through price escalators included in multiyear contracts, while also securing some price adjustments outside of these agreements.

[Tom Werner, President and CEO at Lamb Weston]

In addition, we've nearly completed negotiating contract renewals that represent about a third of our global segment volume. Overall, we feel good about how the discussions played out and will generally begin to see the results of these new pricing structures during the second half of Fiscal 2023. Finally, with respect to this year's potato crop, our preliminary view is the potato crop in our growing regions in the aggregate will be around the lower end of historical average range. Specifically, the overall quality of the crop, including shape, color, level of defects, and solid content, is good and consistent with historical averages. Yields, however, are below average. The unusually hot weather during August affected the growth of the potatoes and resulted in a greater than average proportion of potatoes failing to bulk up to the desired size.

[Tom Werner, President and CEO at Lamb Weston]

In response, we've already begun to secure the additional potatoes needed to meet our production forecast and expect to purchase most of this from growers in the Columbia Basin in Idaho. That's in contrast to last year when we purchased potatoes at significant premiums to contracted prices and transported them from as far away as the East Coast. As you may recall, our financial targets for the year were predicated in part on an average potato crop, and we believe this crop is broadly consistent with our expectations. While below average yields will result in additional open market purchases at higher than contracted prices, we do not expect this to affect our ability to deliver our financial targets.

[Tom Werner, President and CEO at Lamb Weston]

To be clear, we view this crop as significantly better than last year's, which was poor both in terms of yield and quality due to the prolonged extreme summer heat in the Pacific Northwest. We'll provide our final assessment of the crop, including how it performs out of storage when we report our second quarter results in early January. In summary, we generated strong sales and earnings growth in the first quarter by executing pricing actions in each of our business segments and driving productivity savings. We expect restaurant traffic and fry demand will be volatile in the near term as consumers continue to adjust to the inflationary environment. On a preliminary basis, we believe the potato crops in our growing regions are at the lower end of historical average range, and that any effect on our operations or financial performance will be manageable.

[Tom Werner, President and CEO at Lamb Weston]

Let me now turn the call over to Bernadette to review the details of our first quarter results and our progress towards our Fiscal 2023 financial commitments.

[Bernadette Madarieta, CFO at Lamb Weston]

Thanks, Tom, and good morning, everyone. As Tom said, we're pleased with our performance in the quarter, and we are confident in our ability to deliver at the high end of our financial target ranges for the year. In the quarter, our sales grew 14% to more than $1.1 billion. Price mix was up 19% as we continued to benefit from product and freight pricing actions that we announced last fiscal year, and as we began to execute new pricing actions during the first quarter. Our sales volumes were down 5%, primarily reflecting the softer restaurant traffic trends in U.S. casual dining and full-service outlets that Tom described earlier, as well as the timing of shipments to large chain restaurant customers.

[Bernadette Madarieta, CFO at Lamb Weston]

In retail, while branded product volumes were up, overall retail segment volumes were down, with the ongoing effect of losing certain low-margin private label business. Sales volumes in food service and retail also continued to be affected by our inability to fully serve customer demand as a result of constrained production at our facilities. Gross profit increased $122 million-$273 million in the quarter. Gross margin expanded nearly 900 basis points versus the prior year quarter and 230 basis points sequentially to more than 24%. Pricing actions and productivity savings drove these improvements, more than offsetting the impact of higher costs on a per pound basis and lower sales volumes. Cost per pound increased high single digits, with inflation again accounting for essentially all of the increase.

[Bernadette Madarieta, CFO at Lamb Weston]

Higher prices for inputs such as edible oils, ingredients for batter and other coatings, labor and transportation were the primary drivers. Potato costs were also up as a result of the poor crop that was harvested last fall. We'll continue to realize the financial impact of this crop through most of the second quarter of Fiscal 2023 as we sell the final finished goods produced from the crop. Finally, we continued to incur higher costs and operational inefficiencies associated with labor, spare parts, and ingredient shortages and other industry-wide supply chain challenges. Benefits from our portfolio simplification and other cost mitigation efforts, however, offset some of these higher costs.

[Bernadette Madarieta, CFO at Lamb Weston]

Moving on from cost of sales, our SG&A increased $25 million-$116 million, largely due to higher compensation and benefits expense and expenses related to improving our IT infrastructure, including designing a new ERP system. Equity method earnings from unconsolidated joint ventures in Europe and the U.S. increased nearly $170 million. More than $140 million of the increase was related to the change in unrealized gains for mark-to-market adjustments related to changes in natural gas and electricity derivatives as commodity markets in Europe have experienced significant volatility. Another $15 million of the increase relates to a gain recognized in connection with our acquiring an additional 40% interest in our joint venture in Argentina.

[Bernadette Madarieta, CFO at Lamb Weston]

Excluding these comparability items, as well as other mark-to-market adjustments not associated with natural gas and electricity derivatives, equity earnings increased $13 million. This largely reflects improved results in our joint venture in Europe. In addition, in September, our European joint venture withdrew from its joint venture in Russia after receiving all regulatory approvals. In the prior year quarter, earnings from the Russia joint venture were not material. Putting it all together, adjusted EBITDA, including unconsolidated joint ventures, nearly doubled to $228 million, while adjusted diluted earnings per share more than tripled to $0.75 per share. Strong sales growth and gross margin expansion primarily drove the increases. Moving on to our segments. Sales in our global segment were up 12% in the quarter.

[Bernadette Madarieta, CFO at Lamb Weston]

Price mix was up 14%, reflecting domestic and international pricing actions associated with customer contract renewals, inflation driven price escalators and higher prices charged for freight. Mix was also positive. Overall segment volumes declined 2% as North American volumes fell primarily due to the timing of shipments to large QSR chain customers, including the effect of lapping a notable limited time product offering in the prior year quarter. Global's product contribution margin, which is gross profit less advertising and promotion expenses, nearly doubled to $84 million. Favorable price mix more than offset the impact of higher manufacturing and distribution costs per pound. Sales in our food service segment grew 14%. Price mix increased 26% as we continued to drive product and freight pricing actions that we announced throughout Fiscal 2022 and earlier in the quarter to counter inflation.

[Bernadette Madarieta, CFO at Lamb Weston]

Sales volumes decreased 12% as casual dining and full-service restaurant traffic softened. While traffic trends progressively softened each month since the war in Ukraine began at the end of February, it began to tick upward in August. Sales volumes were also affected by the timing of incremental losses of certain low margin non-commercial business, as well as our inability to fully serve demand as a result of constrained production. Food services product contribution margin rose more than 40% to $138 million, as favorable price more than offset higher manufacturing and distribution cost per pound and the impact of lower volumes. In our retail segment, sales increased 28%. Price mix was up 32%, reflecting pricing actions across our branded and private label portfolios, as well as favorable mix with the sale of more branded products.

[Bernadette Madarieta, CFO at Lamb Weston]

Volume was down 4%, reflecting incremental losses of certain lower margin private label products. We'll be lapping the last of that lost private label business in the second quarter. Sales volumes were also tempered by our inability to fully serve customer demand due to the constrained production. Retail's product contribution margin more than tripled to $49 million behind pricing actions and favorable mix. This was partially offset by higher manufacturing and distribution cost per pound. Moving to our liquidity position and cash flow. We ended the quarter with $485 million of cash and a $1 billion undrawn revolver. While our net debt remained relatively flat at about $2.25 billion, our leverage ratio fell to 2.7x from 3.1x at the end of the Fiscal 2022 as earnings grew.

[Bernadette Madarieta, CFO at Lamb Weston]

We generated more than $190 million of cash from operations, which is up about $30 million versus the prior year quarter, largely due to higher earnings. Capital expenditures were about $120 million. That's up about $40 million as we continue to construct new French fry lines in Idaho and China. In addition, we paid about $42 million to acquire the additional 40% interest in our joint venture in Argentina. We now own 90% of that joint venture. We returned $64 million of cash to our shareholders in the form of dividends and share repurchases and have about $240 million of authorization remaining under our share repurchase program. Turning to our Fiscal 2023 outlook. Our financial targets for the year remain unchanged as we continue to build our operating momentum.

[Bernadette Madarieta, CFO at Lamb Weston]

While the macro environment remains volatile, we're on track to deliver at the high end of our sales target of $4.7 billion-$4.8 billion with price driving the growth. We'll continue to realize the carryover benefit of product pricing actions in our food service and retail segments. In our global segment, we expect to see the benefit of pricing actions, including pricing structures for contract renewals built as the year progresses. Forecasting volume continues to remain more difficult due to the near term volatility in restaurant traffic and demand. As we saw in the first quarter, we believe that consumer behavior during inflationary or recessionary times will continue to affect overall demand as well as our sales channel and product mix, with QSRs and retail outlets benefiting at the expense of casual dining and full-service restaurants.

[Bernadette Madarieta, CFO at Lamb Weston]

In addition, we expect our sales volumes will be affected by near term production and throughput constraints as we continue to face disruptions in the availability of key product inputs and spare parts. Additionally, while labor and access to shipping containers have improved, we continue to see the impact of shortages. We're on track to deliver at the high end of the range of our earnings targets, including adjusted net income of $360 million-$410 million, adjusted diluted earnings per share of $2.45-$2.85, and adjusted EBITDA, including unconsolidated joint ventures of $840 million-$910 million. These targets exclude the items impacting comparability that I described earlier.

[Bernadette Madarieta, CFO at Lamb Weston]

We expect our earnings increase will be driven primarily by sales growth and gross margin expansion. We continue to expect gross margins during the second half of Fiscal 2023 that approach our normalized annual rate of 25%-26%, and we feel good about the four key factors underlying this target. First, as Tom noted, we believe the potato crops in our primary growing regions will be at the lower end of the historical average range, and that any effect on our operations and financial performance will be manageable. Second, we're pleased with the continued progress in implementing pricing actions to counter cost inflation. Third, we're making steady progress in adding production workers in order to ease labor pressures in our factories. Finally, the availability of domestic rail and trucking assets, as well as access to shipping containers continues to improve.

[Bernadette Madarieta, CFO at Lamb Weston]

While a broad rail strike has likely been averted, we continue to closely monitor the status of discussions with the International Longshore and Warehouse Union and the impact of potential work slowdown or stoppage may have on our exports. We continue to target SG&A expenses of $475 million-$500 million, which reflects higher compensation and benefits expenses to attract and retain talent, higher spending for our new ERP system and other IT infrastructure upgrades, higher advertising and promotion expenses as we look to return support back to historical levels and overall inflation for third-party services. We continue to expect equity earnings of $25 million-$30 million, excluding items impacting comparability, but also expect increased volatility given the likelihood of a poor crop in Europe, as well as possible limitations on natural gas usage that may affect our production.

[Bernadette Madarieta, CFO at Lamb Weston]

In addition, we believe that the severe inflation outlook for Europe will likely translate into more pressure on restaurant traffic and demand. Our estimates for our other financial targets are unchanged, including capital expenditures of $475 million-$525 million, excluding acquisitions, interest expense of approximately $115 million, depreciation and amortization expense of about $210 million, and an effective tax rate excluding items impacting comparability of about 24%. Now, here's Tom for some closing comments.

[Tom Werner, President and CEO at Lamb Weston]

Thanks, Bernadette. Let me quickly sum up by saying we are managing well through this challenging environment and continue to build good operating momentum. We're well-positioned to deliver at the upper end of our financial target ranges for the year, and we're making the necessary investments in our production capacity and operating infrastructure to support long-term growth and create value for our shareholders. Thank you for joining us today, and now we're ready to take your questions.

[Operator]

Well, thank you. If you would like to signal with questions, please press star one on your touch tone telephone. If you're joining us today using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that is star one if you would like to signal with questions. Our first question will come from Chris Growe with Stifel.

[Chris Growe, Managing Director at Stifel]

Thank you. Good morning.

[Tom Werner, President and CEO at Lamb Weston]

Good morning, Chris.

[Bernadette Madarieta, CFO at Lamb Weston]

Good morning.

[Chris Growe, Managing Director at Stifel]

Hi. Thank you. Hi. I just had a quick question for you, very strong first quarter performance. Congratulations on that. Obviously, you are looking more towards the higher end of your guidance now for the year. With this strong first quarter and this recovery in the gross margin, it would seem like you could see an even stronger EBITDA performance.

[Chris Growe, Managing Director at Stifel]

I realize it's early in the year, but I just wanna get a sense of items maybe like in SG&A, if there's investments you can make there or perhaps even in, you know, as you start to, you know, kind of rebuild your production with better labor and availability and that, if there's some items like that we should keep in mind as we move through the year, that could put a bit of a limit on the EBITDA performance.

[Tom Werner, President and CEO at Lamb Weston]

Yeah, Chris, this is Tom. You know, I'll just reiterate we're off to a terrific start this fiscal year, and our focus, you know, you think about a year ago, our focus has been rebuilding our margin structure back to pre-pandemic levels. That's the focus of the team, and they've done a terrific job. You know, just in terms of SG&A, and I'll let Bernadette add onto this, you know, we had some elevated spend due to the ERP, a lot of it. You know, there's some wages also that has increased our SG&A based on the market conditions we have. You know, it's really about focusing on the mix, margin management. That's what we've been focused on for the last year when I started talking about it.

[Tom Werner, President and CEO at Lamb Weston]

The team's done a great job executing that. It's, you know, the volume's a little bit choppy right now, and I think that's gonna continue for the balance of this fiscal year, just based on the economic environment we're all operating in and as well as, you know, some of the supply chain issues we continue to experience within freight and containers, those kind of things. You know, it's early. We gotta understand how the crop processes through the factories the next 60 days. You know, on that note, in Q2, we'll reassess kind of how we're feeling about the year.

[Chris Growe, Managing Director at Stifel]

Okay. Thank you. Just a follow-up question on your gross margin. Obviously, it's a much stronger gross margin here in the first quarter than we expected, and really more like your historical first quarter gross margin performance. I realize there's a lot going in the gross margin today, from pricing and cost inflation and the old crop and all that. I just wanna get a sense of the factors that are aiding the gross margin performance this quarter. Maybe along with that, just to get a sense of how much these supply chain challenges are still weighing on the gross margin.

[Chris Growe, Managing Director at Stifel]

Thank you.

[Tom Werner, President and CEO at Lamb Weston]

Yeah. You know, Chris, the main factor, if you think about a year ago, we were at 15% margin. You know, it's really focused on pricing through inflation. We have absorbed a tremendous amount of cost inflation in this business, just like everybody else has in the space. It's really driving pricing to offset inflation. We're making, obviously, great progress against that. We have a lot more to do. You know, it's still from an input cost standpoint, we're gonna see more inflation coming at us, you know, in the future, so we're adjusting our pricing architecture to offset that as much as we can, and we believe we will. You know, that's kind of the driver, Chris.

[Bernadette Madarieta, CFO at Lamb Weston]

Yeah. You know, we are making steady progress as we add production workers, based on some of the actions that we've taken to attract and retain employees while there's still those labor shortages. You know, we are seeing the impact of that and some of the changes we've made to shift schedules and other things. Just getting back to your run rates and throughput question.

[Tom Werner, President and CEO at Lamb Weston]

Yeah. One of the big challenges we still have is container issues for our international business, Chris. While it's getting better, it's still hindering our ability to ship to some of our international markets in a pretty significant way, which is impacting the overall volume in our global business unit. The team's working through it as best we can, but it's still challenging from a container standpoint on the West Coast.

[Chris Growe, Managing Director at Stifel]

Okay. Well, thank you. It was a lot of good color. I appreciate it.

[Tom Werner, President and CEO at Lamb Weston]

Yep.

[Bernadette Madarieta, CFO at Lamb Weston]

Thank you.

[Operator]

Thank you. Our next question will come from Peter Galbo with Bank of America.

[Peter Galbo, Director and Head of US Consumer Staples Equity Research at Bank of America]

Hey, guys. Good morning. Thanks for taking the question.

[Bernadette Madarieta, CFO at Lamb Weston]

Good morning.

[Tom Werner, President and CEO at Lamb Weston]

Morning.

[Peter Galbo, Director and Head of US Consumer Staples Equity Research at Bank of America]

Tom, I just wanted to ask actually like a more of a technical question, I guess, around the 2022 potato crop. You know, realizing that yields are down and maybe the sizing is down a bit, but with the quality being good, can you just, I guess, educate us a little bit more on why the quality being, you know, above average or very good kind of helps pull up, you know, maybe a down yield year? You know, what that does for you from a manufacturing standpoint.

[Tom Werner, President and CEO at Lamb Weston]

Yeah. The way to think about it is the quality of the potato, as we're manufacturing it or running it through the factories, it will provide, you know, good solids and good color, and the length is fine. Which last year we had all kinds of issues with the crop. Set that aside, quality's good. The finished product's gonna be more normalized, I'll say. The yield impact is literally there's just less potatoes on the plant as it grows than what we historically have. It's just, you just have less potatoes per acre. I feel great about our ability to procure open potatoes as we have every year. We do it every year.

[Tom Werner, President and CEO at Lamb Weston]

While it's not at historical levels, like we said on the call, we will manage through it. We have a great ag team that will help us manage through it and procure the potatoes, and we'll be able to, you know, deliver our customers the product they need.

[Bernadette Madarieta, CFO at Lamb Weston]

Yeah. Tom, if I could add on to that. In terms of the quality component, you know, being better this year where it was worse last year, that lower quality really resulted in lower potato utilization, so it required more potatoes to produce the same amount of finished goods. We're not gonna have that issue this year with a better crop in terms of quality. Then potato quality also affects line speed times in our plants. Again, we won't have that issue this year with a better quality crop.

[Peter Galbo, Director and Head of US Consumer Staples Equity Research at Bank of America]

Got it. That was gonna be my follow-up, so thanks for that, Bernadette. Then maybe just as a second question, more of a technical question for modeling purposes. You know, just can you quantify at all the shipment timing impact on QSRs in the first quarter? You know, does that shift to the second quarter at all? Then just, again, seasonally, you know, I think historically, gross margins tick up from 1Q to 2Q in a normal year. Shall we expect, you know, some of that normal sequential acceleration into the second quarter? Thanks very much.

[Bernadette Madarieta, CFO at Lamb Weston]

Yeah. As it relates to our gross margin, we'll continue to see the normal seasonality. As it relates to the first question and the impact of the QSR, you know, we don't give certain guidance as it relates to specifics, but essentially that will flow through in the second quarter in terms of timing, just given the delay in shipments.

[Peter Galbo, Director and Head of US Consumer Staples Equity Research at Bank of America]

Great. Thanks very much.

[Operator]

Our next question comes from Tom Palmer with JPMorgan.

[Tom Palmer, VP of Equity Research at JPMorgan]

Good morning, and thanks for the question. I wanted to ask on COGS inflation expectations. Sounds like based on Bernadette's prepared remarks that maybe it decelerated just a little bit in the first quarter. Is the assumption that as the year progresses, you see the rate of inflation ease a little bit? Just wondering what's kind of embedded in that.

[Bernadette Madarieta, CFO at Lamb Weston]

Yeah. We did end the quarter with high single-digit, you know, cost inflation, including transportation. We also had some of the increased costs related to inefficiencies for run rates. Those were the two pieces. As it relates to inflation, though, going forward, although they've come off their recent highs, you know, they still do remain well elevated compared with pre-pandemic levels. It also will be impacted going forward by the timing of when some of our hedges drop off for some of our natural gas.

[Tom Palmer, VP of Equity Research at JPMorgan]

Okay. Understood. Just maybe get a quick recap of pricing actions at this point. You cited list price increases that flowed through during the first quarter, so I guess presumably they'll be carry over in the second quarter. From a list price standpoint, is there anything beyond that at this point, or is kind of a next step up as we move into the new year and global contracts are adjusted?

[Tom Werner, President and CEO at Lamb Weston]

Yeah. The big thing, Tom, is our global contract negotiations are kind of wrapping up for this next fiscal year. Most of those will start flowing through in the back half. As I said in the remarks, we feel good about where all those ended up. You know, we'll start seeing those realized in the back half. In terms of the other segments, you know, we've been ahead of the curve in terms of the pricing to offset inflation. We, as we always do, we'll continue to evaluate, based on what we're seeing on our cost structure, evaluating when we go to market and change prices going forward in the retail and food service segment.

[Bernadette Madarieta, CFO at Lamb Weston]

Yeah, that's right. The last price increase that we announced in food service retail in July, you'll begin to see more benefit of that in Q2, Q3.

[Tom Werner, President and CEO at Lamb Weston]

You might start to see a little bit of slowdown in transport, though, just so you have that. Remember, we've been talking about product pricing here, but transport will start to come off a little bit, just as the cost of transport goes down as it, and most people on the call know that we try to make that as a pass-through as possible. It's, you know, over time, it tends to be gross profit neutral, but it will be a little bit more volatility on the top line because of that.

[Tom Palmer, VP of Equity Research at JPMorgan]

Okay. Thanks for all the details.

[Tom Werner, President and CEO at Lamb Weston]

Thanks, Tom.

[Operator]

Our next question will come from Rob Dickerson with Jefferies.

[Rob Dickerson, Managing Director of Consumer Staples Equity Research at Jefferies]

Great. Thanks so much. Let me just get a follow-up on the gross margin statement in the back half. You know, Q1 gross margin obviously really impressive. Kind of flatline off.

[Tom Werner, President and CEO at Lamb Weston]

Hey, Rob, you're breaking up a little bit.

[Rob Dickerson, Managing Director of Consumer Staples Equity Research at Jefferies]

Oh, I'm sorry. Yeah, sorry. I was just saying gross margin in the first quarter was obviously impressive, not that far from expectations in the back half. It sounds like, you know, contract negotiations this summer in global have gone well. I guess, you know, as we think kind of just to that Q3 time period with some of the incremental pricing coming through, like, Tom, what would you consider, you know, some of the drivers that might get you at the high end of that gross margin guide in the back half, maybe some of the drivers to get you to the lower half from it or to the lower end?

[Rob Dickerson, Managing Director of Consumer Staples Equity Research at Jefferies]

It sounds like it's kinda more of the demand side relative to maybe volatility on cost or pricing, or anything around the crop. Thanks.

[Tom Werner, President and CEO at Lamb Weston]

Yeah, Rob, you know, as we've been very consistent, I feel good about where our gross margins are going to progress towards our historical averages in the back half pre-pandemic. That's what our focus is on, and we're off to making good progress against that, obviously. You know, so I feel confident about us returning back to normalized levels. You know, so I'm not gonna talk about high end, low end, all those kind of things, Rob. I just, it's about making progress, and we're doing that as an organization, and the team's executing against that.

[Rob Dickerson, Managing Director of Consumer Staples Equity Research at Jefferies]

All right, fair enough. And then just quickly, Tom, I know you said early on in the call, you know, it sounds like you've been able to secure incremental supply just given a, you know, a little of a lower yield on the crop. Like, at this point, you know, kind of given where you stand, is it fair to say that, you know, you have plenty of supply, right? You have plenty of potatoes. As you kinda get through the fiscal year, this shouldn't be, like, an issue where we're sitting here in March or April such that, you know, the market's all out trying to, you know, fight for potatoes in the open market. That's it. Thanks.

[Tom Werner, President and CEO at Lamb Weston]

Yeah, Rob, I feel great. We have great partner growers. You know, we work in tandem with them on our needs, and we got a great ag team that has tremendous relationships with our growers. I feel confident that we'll be able to execute against our production plan and sales plan for the year. You know, we have some things we can do to adjust new crop, old crop. I feel good about where we're positioned going forward.

[Rob Dickerson, Managing Director of Consumer Staples Equity Research at Jefferies]

All right, super. Thanks a lot.

[Operator]

Our next question will come from Adam Samuelson with Goldman Sachs.

[Analyst at Goldman Sachs]

Good morning, everyone. Thank you for taking my question.

[Bernadette Madarieta, CFO at Lamb Weston]

Morning, Adam.

[Tom Werner, President and CEO at Lamb Weston]

Morning, Adam.

[Analyst at Goldman Sachs]

This is actually Guillermo stepping in for Adam. I was wondering if you could help us understand a little bit better your underlying assumptions as it relates to your guidance. You reaffirm it. Now that we have three more months, has anything changed in terms of your underlying price mix assumptions or volumes?

[Bernadette Madarieta, CFO at Lamb Weston]

Yeah, thanks, Adam. No. There's four key factors that we've alluded to in our prepared remarks as it relates to our guidance that we've been watching, and that's crop pricing, our run rates, and then logistics. We feel good about where we're at on all of those. Therefore, I think we'll be at the higher end of the range of our earnings targets that we have outlined. Feel good about all four of those factors.

[Analyst at Goldman Sachs]

That's helpful. Thank you. As a follow-up, as it relates to your investment in Argentina, how does it benchmark in terms of profitability versus the rest of the portfolio?

[Tom Werner, President and CEO at Lamb Weston]

Well, this is Tom. You know, it's right in line with our long-term strategic growth plans. It gives us in-country production capabilities alongside of our, you know, we have a joint venture down there, and you know, it gives us a footprint in the South American market, which is a huge market, and we're under-indexed in terms of share. And it's super cost competitive. So I feel good about our investment. It's right along our strategic long-term plan that we've been executing against for the past six years. And I'm excited about it, and it's gonna give us a tremendous competitive advantage in that market down there going forward.

[Bernadette Madarieta, CFO at Lamb Weston]

Yeah. We expect that the return on that expansion, you know, to be attractive and in line with our other expansions.

[Analyst at Goldman Sachs]

That's super helpful. Thank you. I'll pass it on.

[Operator]

Moving on to William Reuter with Bank of America.

[William Reuter, Managing Director at Bank of America]

Hi. Good morning. I just have two.

[Tom Werner, President and CEO at Lamb Weston]

Go ahead.

[William Reuter, Managing Director at Bank of America]

The first is with the second year of kind of below average crop yields. Has there been any change in the amount of area or land that is being dedicated to the production of potatoes? I'm wondering whether there could be long-term implications if some of the growers aren't making as much money as they historically did.

[Tom Werner, President and CEO at Lamb Weston]

No. I mean, this is Tom. The acres fluctuate a bit, nothing major. The acres around our growing areas has been pretty consistent over time. You know, there is some change, but it's really has not been material, as long as I've been around this business.

[William Reuter, Managing Director at Bank of America]

Great to hear. Kind of on a related topic, there is some trade press that suggests that some of your contract negotiations in the Columbia Basin are already complete for Calendar Year 2023. Is there anything you can provide there in terms of color?

[Tom Werner, President and CEO at Lamb Weston]

Yeah. No, we won't provide any color on that. The next couple of calls as some of those things finalize as we always do, you know, we'll communicate that on one of these calls in the near future once everything's done.

[William Reuter, Managing Director at Bank of America]

Understood. Sounds good. Thank you.

[Tom Werner, President and CEO at Lamb Weston]

Yep.

[Bernadette Madarieta, CFO at Lamb Weston]

Thank you.

[Operator]

As a reminder, if you would like to signal with questions, please press star one on your touch tone telephone. Again, star one. Moving on to Carla Casella with JPMorgan.

[Carla Casella, Managing Director at JPMorgan]

Hi. Thanks for taking the question. I'm wondering, you've been spending a lot of your investing on additional capacity. Can you talk about whether your view towards M&A or further JV investments may change as those facilities are done, or is that not inhibiting any of your M&A, JV investment opportunities?

[Tom Werner, President and CEO at Lamb Weston]

Yeah. This is Tom. You know, strategically, you know, our investment in expanding capacity has been very consistent. As we see the category growth and we think about the next really two, three, four, five, seven years, as the category continues to grow, even at low single digits, it's a big growth number in terms of overall volume. Over time, we're gonna continue to invest in the business and invest in the growth of the category. In terms of M&A, I've been very consistent since I've been sitting in this chair that we are as active as we can be in pursuing M&A actions. You know, the timing of those are always hard to predict.

[Tom Werner, President and CEO at Lamb Weston]

It is absolutely going forward part of our growth strategic plan, organic capacity investment and potential M&A as those opportunities present themselves.

[Carla Casella, Managing Director at JPMorgan]

Okay, great. Did you, I might have missed it. Did you give a leverage target?

[Bernadette Madarieta, CFO at Lamb Weston]

Yeah. Our leverage target remains the same at 3.5x-4x. Certainly, we're considerably below that right now. You know, we maintain that strong balance sheet during these periods of economic volatility, and it preserves optionality for M&A.

[Carla Casella, Managing Director at JPMorgan]

Okay, that's great. Just one last one on hedging. Can you just talk about what you can and are hedging and if your view or policies are changing there just in light of the current environment?

[Bernadette Madarieta, CFO at Lamb Weston]

Yeah. Just high level, we do hedge our natural gas and oil, that's used in processing our potatoes. Our policies have not changed. We've always had a risk oversight committee that has monitored the markets, and we've entered into those contracts as we've seen appropriate.

[Carla Casella, Managing Director at JPMorgan]

Deb, you said how much you're hedged in for the year?

[Bernadette Madarieta, CFO at Lamb Weston]

We haven't disclosed that.

[Carla Casella, Managing Director at JPMorgan]

Okay, great. Thank you.

[Operator]

Thank you. That does conclude the question and answer session. I'll now turn the conference back over to Mr. Congbalay for any additional or closing remarks.

[Dexter Congbalay, VP of Investor Relations at Lamb Weston]

Thanks for joining us today. If you wanna set up a follow-up call, please email me, and we can set up a time to either today or in the following days. Thanks again for joining, and I'll talk to you later. Bye.

[Operator]

Thank you. That does conclude today's conference. We do thank you for your participation. Have an excellent day.

Participants

Executives

• Bernadette Madarieta, CFO
• Dexter Congbalay, VP of Investor Relations
• Tom Werner, President and CEO

Analysts

• Carla Casella, Managing Director at JPMorgan
• Chris Growe, Managing Director at Stifel
• Peter Galbo, Director and Head of US Consumer Staples Equity Research at Bank of America
• Rob Dickerson, Managing Director of Consumer Staples Equity Research at Jefferies
• Tom Palmer, VP of Equity Research at JPMorgan
• William Reuter, Managing Director at Bank of America
• Analyst at Goldman Sachs