Lamb Weston Q3 2022 Earnings Call Transcript

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Provided by Quartr
April 7, 2022

Key Takeaways

  • Q3 sales increased 7% to $955 M and gross margin expanded 110 bps YoY to over 23% driven by pricing actions and cost mitigation efforts.
  • Foodservice segment sales rose 34% with volume up 12% and price/mix up 22%, resulting in a 52% increase in segment contribution margin year-over-year.
  • Global segment volumes fell 6% overall and exports plunged nearly 20%, constrained by shipping container shortages and freight network disruptions.
  • The company secured nearly all required potato acres for FY 2023 at a 20% higher contracted price, with the impact expected in Q2 as the new crop is processed.
  • Despite Omicron, a poor potato crop, labor shortages, and freight challenges, Lamb Weston remains on track to meet full-year guidance and its Idaho and China capacity expansions remain on schedule.
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Earnings Conference Call
Lamb Weston Q3 2022
00:00 / 00:00

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Operator

Good day, and Welcome to the Lamb Weston Third Quarter 2022 Earnings Call. Today's call is being recorded. At this time, I'd like to turn the call over to Dexter Congbalay, Vice President of Investor Relations of Lamb Weston. Please go ahead.

Dexter Congbalay
Dexter Congbalay
VP of Investor Relations at Lamb Weston

Good morning, and thank you for joining us for Lamb Weston's Third 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 Werner, our President and Chief Executive Officer, and Bernadette Madarieta, our Chief Financial Officer.

Dexter Congbalay
Dexter Congbalay
VP of Investor Relations at Lamb Weston

Tom will provide some comments on our performance, as well as an overview of the current operating environment. Bernadette will then provide some details on our third quarter results and updated fiscal 2022 outlook. With that, let me now turn the call over to Tom.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Thank you, Dexter. Good morning, and thank you for joining our call today. First of all, I wanna thank all my colleagues for their continued dedication and perseverance to keep Lamb Weston as an industry leader and a strong business partner. Our solid financial results in the third quarter are a direct result of how well our manufacturing, supply chain, and commercial teams have remained focused on improving our operations and serving our customers during a challenging macro environment, which includes the impact of an exceptionally poor potato crop. We continue to be encouraged by strong French fry demand and feel good about our continued progress. Specifically, in the third quarter, we delivered solid sales growth and drove sequential and year-over-year gross margin expansion, and we did this despite the impact of Omicron variant, slowing restaurant traffic, and disrupting our production and distribution operations more than we expected.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

We benefited from our previously announced pricing actions to mitigate the significant cost inflation across our supply chain. We've also been driving improvements in our manufacturing operations as we focus on what's in our control. This includes mitigating some of the effects of the poor potato crop with product specification changes and portfolio optimization work that we've discussed previously. Factory labor remains challenging as we remain below preferred staffing levels, but we're making steady progress in a highly difficult labor market. We're addressing the labor gap by focusing on retention and new ways of attracting talent. We'll continue to push hard on our staffing initiatives and are encouraged by the improvements we're seeing. However, we'll take time to get all of our factory staff where they need to be. Like others, we're managing through freight challenges, including both cost increases and shipping delays.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

The freight challenges are impacting our top line as it limits our ability to service full demand. This is caused by a lack of containers for international and domestic shipments and truck driver shortages. This, combined with higher fuel costs, has also increased our cost to deliver products. We're continuing to navigate through these and other operating challenges and remain on track to deliver our financial commitments for the year. Our capacity expansion investments in Idaho and China also remain on track and will have us well positioned to support increasing customer demand over the long term. Let me provide some brief updates on the operating environment before turning the call over to Bernadette. Let's start with demand. In the U.S., overall fry demand and restaurant traffic in our third quarter remained solid, although it weakened temporarily as the Omicron variant spread quickly.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Omicron's impact peaked in January and affected consumer traffic at both quick-service and full-service restaurants. In addition, some restaurants closed temporarily or reduced operating hours due to staff shortages, which further impacted demand. Restaurant traffic, however, has rebounded to pre-Omicron levels. 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, has been fairly consistent since the beginning of the pandemic and remains above pre-pandemic levels. Going forward, we expect restaurant traffic and consumer demand for fries in the U.S., to remain strong, although it may be more volatile in the near term as consumers face significant cost inflation. In contrast, fry demand in retail channels may continue to benefit if demand in out-of-home channels is affected. Outside the U.S., demand in Asia and Oceania remains stable.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

However, we have not been able to meet that demand due to the limited availability of shipping containers for export. While we expect overall demand in these regions to return to pre-pandemic levels, widespread COVID-related government restrictions in key markets such as China may lead to demand volatility in the near term. Demand in Europe, which is served by our Lamb-Weston/Meijer joint venture, has also been fairly stable, although it was temporarily affected by the spread of Omicron during the quarter. As in the U.S., we expect demand in Europe may be volatile in the upcoming months as cost inflation and COVID variants temper restaurant traffic.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Overall, while we expect that demand in the near term will be choppy, we remain confident in the long-term resiliency and growth prospects of the category in the U.S., and our key international markets. With respect to pricing, our price mix growth accelerated sequentially in the third quarter as we continued to execute on our previously announced product and freight pricing actions in our food service and retail segments to offset inflation, and as we began to implement pricing actions in our global segment. Going forward, if we see further inflation, we're prepared to take additional pricing actions as well as drive opportunities to improve product and customer mix. To that end, last week, we began implementing another round of pricing actions in our food service and retail segments, and we expect to see the benefits of these actions gradually build over the next six months.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

In our global segment, contracts representing about 1/3 of the segment's volume are up for renewal this year. We've begun discussions with those customers and expect to have most of the contract terms agreed by early fall. With respect to this year's upcoming potato crop, we've agreed to a 20% increase in the contracted price per pound in our primary growing regions in the Columbia Basin, Idaho, Alberta, and the Midwest. This increase reflects our approach for annual price changes that reflect the cost to grow, plus an appropriate return for our growers such that they are viable over the long term. We'll begin to see the impact of these higher contracted potato prices during the second quarter of fiscal 2023, as we begin to process the early potato varieties that are harvested in mid-summer.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

In addition, over the past few months, we've partnered with our growers to contract for acres that represent nearly all of our projected needs associated with this year's crop. The number of acres contracted assumes an average crop year. Planting of this year's potato crop started in March and typically concludes by the end of April, and we'll provide our usual crop updates during future quarterly earnings calls as the growing season progresses. Finally, our hearts go out to all the people affected by Russia's invasion of Ukraine. Our exposure to Russia is indirect as it runs through our 50% ownership in Lamb-Weston/Meijer. Last month, the Russia JV began winding down production of Lamb Weston branded products and paused construction of its previously announced capacity expansion.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

We continue to monitor the situation and any decisions regarding that operation will be made in conjunction with our partner in Europe. In summary, we feel good about our progress in the quarter, especially given the highly challenging operating environment, and we remain on track to deliver our financial commitments for the year. Our pricing actions and cost mitigation efforts enabled us to drive sequential and year-over-year gross margin expansion. We've agreed on contract price and acres to be planted for this year's potato crop, and we remain confident in the resiliency and long-term growth prospects of the category, although demand may be volatile in the near term. Let me now turn the call over to Bernadette to review the details of our third quarter results and our updated fiscal 2022 outlook.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Thanks, Tom, and good morning, everyone. Let me start by echoing Tom's comments, thanking our employees. We appreciate your hard work and dedication. As Tom discussed, we feel good about the benefits from our pricing actions and cost savings efforts to offset much of the significant cost inflation that we've been experiencing, and I'm confident in our ability to continue to manage through this volatile business environment. Specifically, in the quarter, our sales increased 7% to $955 million. Price mix was up 12% as we continued to execute our previously announced product and freight pricing actions in each of our business segments to offset input, manufacturing, and transportation cost inflation. Most of the increase in the quarter reflects these pricing actions, while mix was also favorable.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Sales volume declined 5% as we were unable to fully serve market demand due to logistics constraints, especially for our international shipments, as well as lower production run rates and throughput at our factories resulting from labor shortages. Increased shipments in our food service segment and to our large chain restaurant customers in North America that are served by our global segment partially offset the volume decline. However, while volume increased in these channels, it was tempered by the Omicron variant's negative effect on restaurant traffic, on the availability of labor to keep restaurants open, and on our production facilities and supply chain. Gross profit in the quarter increased $24 million. Product and freight price increases, along with favorable mix, more than offset the impact of higher costs on a per pound basis and lower sales volumes.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

We expanded gross margin by 110 basis points versus the prior year quarter and 270 basis points sequentially to more than 23%. Looking at our costs, double-digit inflation drove the increase in cost per pound for the third straight quarter and accounted essentially for all of the increase in the quarter. There were four key areas that drove the increase in cost. First, commodities played the biggest role, led by edible oils, ingredients for batter and other coatings, and packaging. Labor costs also increased due to competition for factory workers. Second, transportation rates continued to climb due to the persistent disruption in global logistics networks.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

We also continued to use an unfavorable mix of higher cost trucking versus rail to meet service obligations for certain customers. Third, we began to see higher potato costs resulting from the poor crop that was harvested last fall in our primary growing regions. The increase in potato costs reflects the impact of purchasing potatoes in the open market at a significant premium to contracted prices, higher transportation costs for shipping potatoes from the Midwest and Eastern North America to our plants in the Pacific Northwest, lower potato utilization rates, and running production lines at lower speeds to accommodate low-quality potatoes.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

The increase in our potato costs, decrease in potato utilization rates, and how the crop is performing in storage are all in line with the expectations that we shared with you last quarter, and we believe we've secured enough potatoes to deliver our volume forecast until we begin to harvest the early potato varieties in July. As a reminder, we will continue to realize the financial impact of this year's poor potato crop through most of the second quarter of fiscal 2023. The final key area that drove the increase in costs are operational inefficiencies explained by labor shortages, Omicron-related absenteeism, especially in January and into early February, and other industry-wide supply chain challenges. This resulted in lower production run rates and throughput in our factories, leading to fewer pounds to cover fixed overhead.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

As I'll discuss later, we'll continue to see the impact of these costs in the fourth quarter. The effect of lower potato utilization and production run rates in the third quarter was largely offset by a range of cost mitigation efforts, including eliminating underperforming SKUs, changes to product specifications, and increased productivity savings from our Win as One and other cost-saving initiatives. In short, we're managing well through this highly inflationary and poor potato crop environment. We feel good about how we are controlling those things that we can control, which led to the year-over-year and sequential gross margin expansion. Moving on from cost of sales. Our SG&A declined $9 million in the quarter, largely due to lower consulting expenses associated with improving our commercial and supply chain operations as those projects ended.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Lower overall compensation and benefits expense and a $2 million decline in advertising and promotion expenses. The decline in SG&A was partially offset by higher information technology infrastructure costs, including costs to design the next release of a new enterprise resource planning system. Equity method earnings in the quarter were $30 million and included a $20 million unrealized gain related to mark-to-market adjustments associated with currency and commodity hedging contracts. The large mark-to-market gain in the quarter primarily relates to changes in the value of natural gas derivatives at Lamb-Weston/Meijer, as commodity markets there have experienced significant volatility. Excluding the impact of these mark-to-market adjustments, equity earnings increased $1 million versus the prior quarter. Favorable price mix and higher sales volumes were largely offset by input inflation and higher manufacturing and distribution costs in both Europe and the U.S. Moving to our segments.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Sales in our Global segment were up 2% in the quarter. Price mix increased 8%, reflecting domestic and international pricing actions associated with customer contract renewals and inflation-driven price escalators. It also reflects higher prices charged for freight. Volume fell 6%. International shipments, which have historically accounted for about 40% of the segment's total volume, were down nearly 20% versus the prior year quarter due to limited shipping container availability and disruptions to ocean freight networks. Sales volumes to North American large QSR and casual dining restaurant customers increased but at a slower rate than previous quarters due to the Omicron's negative impact on consumer traffic. Global's product contribution margin, which is gross profit less advertising and promotional expenses, declined 8% to $73 million.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Higher manufacturing and distribution cost per pound as well as the impact of lower sales volumes more than offset the benefit of favorable price/mix. Moving to our Foodservice segment. Sales increased 34%, with price/mix up 22% and volume up 12%. As expected, the rate of increase in Foodservice price/mix accelerated sequentially to 22% in the third quarter from 8% in the second quarter as the benefits of the product and freight pricing actions that we began implementing earlier this fiscal year to mitigate inflation continued to build. In addition, the increase reflects favorable product and customer mix. The ongoing recovery in demand from small and regional restaurant chains and independently owned restaurants, as well as from non-commercial customers, drove a 12% increase in sales volumes.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

While our shipments to restaurants have essentially returned to pre-pandemic levels, our shipments to non-commercial channels have not yet fully rebounded. As with our sales to large chain restaurants in our global segment, the food service segment's volume growth was tempered by Omicron's negative impact on restaurant traffic and labor availability in those restaurants. In addition, manufacturing labor shortages and the effect of Omicron related absenteeism limited our ability to fully serve demand due to lower production run rates and throughput in our factories. Food services product contribution margin rose 52% to $107 million, with favorable price, volume and mix more than offsetting higher manufacturing and distribution costs per pound. In our retail segment, sales declined 12%, with volume down 24% and price mix up 12. The volume decline reflected two factors.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

First, more than half of the decline was due to incremental losses of certain lower margin private label products. Second, despite solid category growth, branded product volumes were down as labor and supply chain disruption limited our ability to service demand. The increase in price mix was driven by product and freight pricing actions across our portfolio to offset inflation as well as favorable mix. Retail's product contribution margin declined 5% to $32 million. Lower sales volumes and higher manufacturing and distribution costs per pound drove the decline, which was partially offset by favorable price mix and a $2 million decrease in A&P expenses. Moving to our liquidity position and cash flow. We ended the quarter with nearly $430 million in cash and $1 billion of availability on our undrawn revolver.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Through the first three quarters of the year, we generated about $175 million of cash from operations. That's down about $200 million versus the first three quarters of the prior year, due primarily to higher working capital and lower earnings. Year to date, we've spent more than $225 million in capital expenditures as we continued construction of our capacity expansions in Idaho and China. We've also returned nearly $230 million of cash to our shareholders, including $103 million in dividends and $126 million in share repurchases. After repurchasing $50 million of shares in the third quarter, we have just under $300 million remaining under our buyback authorization. Now let's turn to our updated fiscal 2022 outlook.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

We expect our full year sales growth to be above our long term target of low to mid single digits. In the fourth quarter, we expect sales to be driven by price mix as we continue to execute our previously announced product and transportation pricing actions to offset input and transportation cost inflation. However, we expect sales volumes will continue to be pressured as export volumes remain constrained due to limited shipping container availability, supply chain volatility and labor shortages challenge run rates and throughput at our factories, and as restaurant traffic and consumer demand may slow due to inflation and the persistent effect of COVID variants in the U.S., and key international markets. In addition, please note that we'll be lapping a high volume comparison in the prior year. With respect to earnings for the full year, we expect our gross margin will be 19%-20%.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

This update puts us at the high end of the 18%-20% range that we provided in our previous outlook. We're comfortable to be at the higher end of that range because of our confidence in the pace and execution of product and freight price increases that we're currently implementing in the market. We have more clarity on the net impact and margin from this year's poor potato crop, and we're making steady progress in stabilizing our supply chain operations and driving savings behind our cost mitigation initiatives. Based on our updated full year estimate, we expect our gross margin in the fourth quarter to be 19%-21%. That's down sequentially from the 23% we delivered in the third quarter and reflects, in part, our usual gross margin seasonality.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

It also includes the impact of significantly higher costs held in finished goods inventory that were produced during the third quarter. These costs were driven by incremental costs and inefficiencies associated with very high levels of Omicron-related factory worker absenteeism in January and February that resulted in broad-based production disruptions. Since we typically hold 50-60 days of finished goods inventory, we'll realize these costs during our fiscal fourth quarter as that inventory is sold. Below gross margin, we expect our SG&A expenses in the fourth quarter to step up to $105 million-$110 million as we continue to invest in the design and build of our new ERP system. We expect equity earnings, excluding the impact of any mark-to-market adjustments, will remain pressured due to input cost inflation and higher manufacturing costs in both Europe and the U.S.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

For the year, we continue to expect interest expense to be approximately $110 million, excluding the $53 million of costs associated with the senior notes that we redeemed in the second quarter, total depreciation and amortization expense of approximately $190 million, and an effective tax rate of approximately 22%. We've reduced our estimate for capital expenditures to $325 million from our previous target of $450 million to reflect the timing of expenditures related to our capacity expansion projects in Idaho and China. In sum, in the third quarter, we delivered solid sales growth and expanded our gross margins behind our pricing actions and our cost mitigation efforts.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

For the year, we're targeting the upper end of our previous gross margin range due to our confidence in our pricing execution to offset inflation, the more clarity that we now have on our potato costs, and the steady progress that we're making in stabilizing labor in our supply chain. Now, here's Tom for some closing comments.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Thanks, Bernadette. Let me just quickly reiterate our thoughts on the quarter by saying I am proud of how our Lamb Weston manufacturing, supply chain, and commercial teams are continuing to take the right operating steps to manage through this challenging business environment. We're on track to deliver on our targets for the year, and we remain committed to investing to support growth and create value for our stakeholders over the long term. Thank you for joining us today, and we're now ready to take your questions.

Operator

Thank you. If you would like to ask a question, you may signal by pressing star one 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 one for questions. We'll take our first question from Peter Galbo with Bank of America.

Peter Galbo
Peter Galbo
Director of Equity Research at Bank of America

Hey, guys. Good morning. Thank you for taking the questions.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Good morning, Peter.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Morning.

Peter Galbo
Peter Galbo
Director of Equity Research at Bank of America

Tom, I wanted to get your thoughts kind of, you know, now that the summer 2022 crop has started to go into the ground. Just how are you thinking about some of the different puts and takes? Obviously, nobody has the perfect crystal ball, but you know, it seems like drought in the Pacific Northwest is still kind of relatively high. You know, you're using a seed crop from last year of a poor crop. You know, heat last year was obviously an issue, fertilizer. Like, how are you thinking about all those puts and takes and encompassed in you know in the what's in the ground?

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Yeah, Peter, it's early on in the planning and how we look at every crop year. Certainly we look at history, but we plan it at average historical levels. In terms of you know the impact that we had last year because of the high heat, which is highly abnormal, you know, it's early innings, and we'll monitor it. No impact from a seed standpoint, but you know, as I said in my prepared remarks, you know, as the crop progresses, as we always do in July and October, we'll give you an update. We plan for an average yield quality crop year every year. You know, we'll adjust it as we learn more as the growing season progresses.

Peter Galbo
Peter Galbo
Director of Equity Research at Bank of America

Got it. No, that's helpful. And Bernadette, maybe if I could ask on gross margins. You know, in your prepared remarks, you mentioned the fourth quarter would follow kind of historical seasonality or more normal historical seasonality. As we continue to process this kind of lower quality crop through the first half of next year, you know, would you still expect, I guess, first quarter or second quarter seasonality to kind of come back into play as other elements of the business start to normalize?

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Yeah, absolutely, Peter. You know, the first half of next year will continue to be affected by this year's poor crop. Once we move into next year's crop, which, as Tom mentioned, we're planning will be average, that's when, you know, we should be able to get closer to those pre-pandemic margins.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Still there, Peter?

Peter Galbo
Peter Galbo
Director of Equity Research at Bank of America

Yep, yep. Sorry. Still here. No, thanks very much, guys. I'll pass it on.

Operator

Thank you. We'll take our next question from Andrew Lazar with Barclays.

Andrew Lazar
Andrew Lazar
Senior Equity Research Analyst at Barclays

Morning, everybody.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Morning, Andrew.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Morning.

Andrew Lazar
Andrew Lazar
Senior Equity Research Analyst at Barclays

Hi. I think, if I'm not mistaken, I think you just may have mentioned that your, I guess, your anticipation would be that you still get back to sort of your more normalized margins in the second half of fiscal 2023. With some of the just the recent news and knock-on effects on the next wave of inflation for a lot of items, you know, even potatoes sort of out of the mix for a minute as those are contracted, you know, I guess, how do you continue to sort of have the comfort level in that?

Andrew Lazar
Andrew Lazar
Senior Equity Research Analyst at Barclays

Is it just that you're seeing obviously the pricing go through and therefore, given what we've seen more recently in terms of incremental costs, there's the confidence that, you know, more can be passed through in a timeframe that allows you to get back to those margins as you had initially expected? Or is there something else?

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Yeah, Andrew, it's a couple things. You know, certainly, an average crop is going to help that, obviously significantly. You know, as we plan our, you know, we're in the middle of planning our fiscal 2023. We have a point of view on what inflation's going to be, which I won't get into until the next call as we wrap our plan for 2023 up. You know, we have, and have been executing our pricing actions. You know, this, as we're all dealing with, you know, inflation is. I'm confident in how we've been executing, and we're in early innings of contract negotiations with some of our bigger customers. We'll work through it, and the team is doing a great job.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

I feel very confident we will pass through this inflation, and we're gonna get some help from the crop next year if it comes in on an average level. Those are really the two things that gives me a lot of confidence that we're gonna get back to pre-pandemic margin levels. There's no indication right now that's telling me that we're not. I feel really good about it.

Andrew Lazar
Andrew Lazar
Senior Equity Research Analyst at Barclays

Great. You know, I realize you're in the early innings of some contract negotiations for the third of those large customer, you know, contracts that are coming up for renewal. For the remainder of them that aren't not yet up for renewal, I know you've talked about the possibility of, you know, sort of maybe expanding the definition of what some of those sort of inflation escalators or how they're defined in those contracts to try and get some relief, even for contracts where they're not up for renewal just yet. I'm just trying to get a sense of how sort of progress has been made there. Are you able to get some additional pricing through, even where there's, you know, not a contract that's up for renewal?

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Yeah. I mean, we're having very robust conversations with those customers, Andrew. You know, we're partnering with them, we're working through it. We're being very transparent with what, you know, what our inflation is, what we're dealing with. I would say those conversations have been very positive. Everybody understands the environment we're all working in. You know, again, the team's doing a great job having those conversations, being very transparent with the customers, letting them know what we're dealing with and what is potentially coming at them, when their contracts are coming due. It's a work in progress, but we are making progress.

Andrew Lazar
Andrew Lazar
Senior Equity Research Analyst at Barclays

Okay. Thank you.

Operator

Thank you. We'll take our next question from Tom Palmer with J.P. Morgan.

Tom Palmer
Tom Palmer
Executive Director of Equity Research at JPMorgan

Good morning. Thanks for the question.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Morning, Tom.

Tom Palmer
Tom Palmer
Executive Director of Equity Research at JPMorgan

First, I just wanted to ask on the potato side, when you consider yield losses and spot market purchases, what is your potato inflation? I'm really just trying to understand how much of the 20% higher contracted rate might be offset by normalized yield per acre and fewer spot market purchases next year.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Yeah, Tom, you know, we won't get into our yield and our processing performance, those kind of things. We don't talk about that. You know, the cost increase is 20%. You know, the big impact are two things to our P&L this year from a potato processing standpoint. It's yield per acre, which is down because of the weather conditions. We've had to procure more potatoes on the open market. You know, it's no secret we truck potatoes from the East Coast, like other processors have, and that costs more money, obviously. It's also how the quality of the potato is processed through our factories. The yield to make a pound of french fries, it takes more potatoes just because of the quality and size and all that.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

It's a you know we take the hit in two different areas. It's yield per acre, and it's processing efficiency in our factories. You know, we haven't disclosed what the overall impact is because we're still trying to understand it as we take these potatoes out of storage. Typically this time of year, it's always a cyclical issue because your quality of potatoes coming out of storage is less than when you're coming right out of field. We're still you know we have an estimate on what the overall impact for the year is going to be, but we're still you know have 2 months to go here, 2, 3, 4, 5 months to go in processing these potatoes.

Tom Palmer
Tom Palmer
Executive Director of Equity Research at JPMorgan

Okay. Understood. Maybe switching just to the capital expansion plan, CapEx coming quite a bit below your initial outlook, indicated in the prepared remarks that both plant expansions remain on track. What's really causing the delays this year, and why is that not affecting the timing? Is it there's just a ton of catch-up coming next year, and as long as that takes place, you'll still be on track?

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Yeah, that's absolutely right. This is Bernadette. It's just a matter of timing and, you know, when those equipment pieces are coming in. Based on our current projections and what we're seeing from our vendors, we're still on track with the estimated completion date. It's just a function of timing between this and next year.

Tom Palmer
Tom Palmer
Executive Director of Equity Research at JPMorgan

Okay, great. Thank you.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

You bet.

Operator

Thank you. We'll take our next question from Robert Dickerson with Jefferies.

Robert Dickerson
Robert Dickerson
Senior Equity Research Analyst at Jefferies

Great. Thanks so much. Tom, just a kind of a question on segment margins, and kind of, you know, the differentiating factors between, let's say, you know, food service, and the global segment. You know, if we look at food service now, right, the op margin Q3 was actually already higher, I believe, than pre-pandemic, which is, you know, a great positive, and it's obviously driven by pricing. The global side, you know, not so much, right? Takes a little bit more time there. Maybe this kind of ties into Andrew's, you know, question on the contracted side. You know, I guess first, if we think about the go forward, where pricing is now in food service, we're assuming kind of, you know, more normalized, you know, demand environment.

Robert Dickerson
Robert Dickerson
Senior Equity Research Analyst at Jefferies

You know, is it your perspective that, you know, that's the margin that we, you know, you hope you can retain, right? As you get into two, four, maybe next year, all things considered. Then on the global side, you know, even, you know, as you get into the back half of next year, even if the crop is, or if it weren't normalized and some of those costs roll off, you know, should that global margin just be going up anyway, you know, just because of the incremental pricing you would be getting, you know, from your other negotiations, in that segment as you get through the summer? Just trying to get a sense of kind of margin potential on the go forward, you know, even if the crop weren't normal. If that makes sense.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Yeah. Well, I you know, the plan is as we look at our inflation, our plan for 2023, we're factoring in you know, pricing actions and cost savings to offset all the inflation and to get our margins back to pre-pandemic levels. That's where we're headed. You know, there's gonna be puts and takes as we you know, as we negotiate these contract prices with our customers. Again, you know, it is dependent upon an average crop, which you know, we'll know in the next six months where the crop's gonna end up. You know, that's where we're driving the business.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

You know, again my confidence level is very high that we're gonna continue to execute towards that based on how we've been executing with the pricing actions we've taken to date. But it's gonna take time. The global segments have lagged. We'll get through the negotiations, and you'll see improvement in the back half in the global segment, specifically.

Robert Dickerson
Robert Dickerson
Senior Equity Research Analyst at Jefferies

Okay, Okay. Maybe just so I understand this a little bit better, you know obviously, the you know, potatoes are contracted, you know, with the growers. You have to go out in the open market, buy some more. Understood. You know, if we're thinking out in a multiyear period, right? As you get to the end of this year, let's say you know, recontract with those growers.

Robert Dickerson
Robert Dickerson
Senior Equity Research Analyst at Jefferies

If there were some, you know increased costs, you know, to the growers, right, as we, you know, get to the end of this year for the forward, I mean, it still sounds as if kind of pass-through pricing ability in the business, you know, would still be alive and well, and the potential for either further pricing, right, on the multiyear would still be possible, right? It's not as if you would say, "Right now, we've taken a lot of pricing. We feel like we're in a good spot. We have to be careful about it." I mean, it's still very contingent on kind of what the cost of those potatoes would be on the go forward. Is that right?

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Well, yeah it is. You know, let me step back. You have to understand what we're doing from a pricing standpoint. We're pricing through inflation, and it's as pervasive as I've ever seen it, a lot of us in the industry. You know, when you think about that and you also think about the importance of french fries on a menu. It's a profit driver. You know, it's gonna be a continuation. Cost to grow is potentially gonna go up, and we'll continue to price through just as we have in past years.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

You know, it's a question of, you know, to me, there is an element that at some point, as if the costs continue to increase to the levels they are, what's the elasticity of a French fry? Right now, we haven't seen it. We'll continue to run our game plan, and we'll adjust to the market, you know, down the road.

Robert Dickerson
Robert Dickerson
Senior Equity Research Analyst at Jefferies

All right. Super. Thank you.

Operator

Thank you. We'll take our next question from Chris Growe with Stifel.

Chris Growe
Chris Growe
Managing Director of Equity Research at Stifel

Thank you. Good morning.

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Morning, Chris.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Morning, Chris.

Chris Growe
Chris Growe
Managing Director of Equity Research at Stifel

Hi. I had a first question, a bit of a follow-on to Rob's question there. You have another price increase going through, I guess that'd be, I think that's in food service and retail. It sounds like that would take hold roughly in September or so if we think about the timing it takes to get that through. I'm just curious how to think about that. Is that related to costs that you're bearing now? Is it any way getting in front of what is going to be a higher potato cost next year and given the timing when this takes hold? I just wanna understand that price increase, if I could.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Yeah, Chris, this is Bernadette. It absolutely is related to the significant cost inflation that Tom was just referring to that we're seeing now. We're passing those costs through, and we'll continue to monitor the environment and the inflation that we continue to see in packaging, ingredients, oil, et cetera, and make decisions in terms of when, you know, further pricing actions may be necessary to offset that significant inflation that we're seeing.

Chris Growe
Chris Growe
Managing Director of Equity Research at Stifel

Have you said what percentage this price increase is?

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

No.

Chris Growe
Chris Growe
Managing Director of Equity Research at Stifel

Do you want to?

Tom Werner
Tom Werner
President and CEO at Lamb Weston

Chris, we don't disclose that.

Chris Growe
Chris Growe
Managing Director of Equity Research at Stifel

Okay. Thank you. I just had one more question for you, if I could, which is that if I'm just thinking about the piece of your global division that was affected by, and you mentioned how it was down 20%+ in volume. Quick math, let's say it's about a 4% drag on volume on the overall company. I just wanna make sure, is that math in the right area there? Maybe related to that then, more importantly, is export volume clearing any more now? Are you getting more on the road? Maybe are competitors coming in, or is anyone else able to come in and satisfy that volume?

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Yeah. As it relates to the global volume, the math you did there is right in terms of the impact on the total company. As we look at export volume, it is starting to increase. We're seeing a few more containers be available than what we saw during the third quarter. That is a positive sign, but it's still much lower than what we've seen previously and what we've come to expect for that international business.

Chris Growe
Chris Growe
Managing Director of Equity Research at Stifel

Okay. Thank you for your time today.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Thanks, Chris.

Operator

As a reminder, star one if you would like to ask a question. We'll take our next question from Adam Samuelson with Goldman Sachs.

Company Representative at Goldman Sachs

Good morning, everyone. Thank you for taking my question. This is actually Guillermo stepping in for Adam. I was wondering if you could provide some additional color on a few items. When we think about the next six-12 months, what are your expectations on cost inflation and what parts of your cost basket have become more or less inflationary compared to your prior call?

Tom Werner
Tom Werner
President and CEO at Lamb Weston

You know, we've indicated we're up 20% on potato raw price. In terms of the overall basket inflation, we're right in the middle of putting together a 2023 plan. You know, we'll give some more color on that in the upcoming earnings calls on what our overall view of inflation is for 2023.

Company Representative at Goldman Sachs

That's helpful. Thanks. If I could ask a follow-up, how does the performance in your JV compare to your base business? Any differences in volume trends or inflationary pressures?

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Yeah, no. As it relates to our joint venture, they're seeing very similar inflationary cost increases. Then more recently, certainly as a result of what's going on between Russia and Ukraine, there have been, you know, large increases in prices for natural gas, and then we've had to make some changes to the oil that's used in that joint venture. Absolutely, they're seeing the same impact on their business as what we're seeing here from an inflation standpoint.

Company Representative at Goldman Sachs

Thanks, and congrats on the quarter.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Thank you.

Operator

We'll take our next question from William Reuter with Bank of America.

William Reuter
William Reuter
Managing Director at Bank of America

Good morning. I know you contract for your raw potatoes. In terms of the other oils that are part of your cost of goods sold, other ingredients, and packaging, what level of forward contracting purchases do you do there?

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Yeah. As it relates to our oil purchases and contracting, as it relates to price, we have contracts in place for first quarter of 2023 and some of second quarter, but a pretty minimal amount. Beyond there, we don't have any other contracts in place.

William Reuter
William Reuter
Managing Director at Bank of America

Perfect. Secondarily, given the delay in CapEx associated with the two expansion projects, do you have an early sense of even ballpark where CapEx could be for fiscal year 2023?

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Yeah. We're in our planning process right now, so, we don't have anything to share today, but certainly we'll provide you an update at our next earnings call.

William Reuter
William Reuter
Managing Director at Bank of America

I understand. Okay, thank you.

Bernadette Madarieta
Bernadette Madarieta
CFO at Lamb Weston

Thank you.

Operator

At this time, that will conclude our question and answer session. I'd like to turn the call back over to Mr. Congbalay for any additional or closing remarks.

Dexter Congbalay
Dexter Congbalay
VP of Investor Relations at Lamb Weston

Thanks for joining the call today. Happy to take any follow-up questions over the next number of days. Please email me so we can schedule a time. Happy opening day, everybody, and kinda go from there. Thank you.

Operator

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

Executives
Analysts
    • Andrew Lazar
      Senior Equity Research Analyst at Barclays
    • Chris Growe
      Managing Director of Equity Research at Stifel
    • Peter Galbo
      Director of Equity Research at Bank of America
    • Robert Dickerson
      Senior Equity Research Analyst at Jefferies
    • Tom Palmer
      Executive Director of Equity Research at JPMorgan
    • William Reuter
      Managing Director at Bank of America
    • Company Representative at Goldman Sachs
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