Lamb Weston Q2 2024 Earnings Report

Lamb Weston EPS Results

• Actual EPS: $1.45
• Consensus EPS: $1.42
• Beat/Miss: Beat by +$0.03
• One Year Ago EPS: $1.28

Lamb Weston Revenue Results

• Actual Revenue: $1.73 billion
• Expected Revenue: $1.70 billion
• Beat/Miss: Beat by +$31.84 million
• YoY Revenue Growth: +35.60%

Lamb Weston Announcement Details

• Quarter: Q2 2024
• Date: 1/4/2024
• Time: Before Market Opens
• Conference Call Date: Thursday, January 4, 2024
• 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 Q2 2024 Earnings Call Transcript

Key Takeaways

• Reported record sales in Q2, driven by consolidation of the EMEA acquisition and solid price/mix growth, though volumes excluding acquisitions declined as low-margin business was exited.
• Took a $71 million charge to write off excess raw potatoes due to over-forecasting contracted acres, reflecting a forecasting misstep and lowering margins.
• Reaffirmed full-year net sales growth and adjusted EBITDA targets, and raised fiscal 2024 EPS guidance to $5.70–$6.15 despite the potato write-off.
• Ongoing ERP system cutover in Q3 is expected to pressure gross margins and constrain shipment visibility, leading to temporary production downtime and weaker sequential volume trends.
• Opened a new greenfield processing facility in China and project that volume trends will continue to improve into Q4, with positive year-over-year growth expected.

Presentation

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Good day, and welcome to the Lamb Weston second quarter earnings call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Dexter Congbalay. Please go ahead, sir.

[Dexter Congbalay, Vice President of Investor Relations at Lamb Weston]

Good morning, and thank you for joining us for Lamb Weston's second quarter of 2024 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 that 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, Vice President of Investor Relations at Lamb Weston]

Tom will provide an overview of the potato crop and the current operating environment. Bernadette will then provide details on our second quarter results, as well as our updated fiscal 2024 outlook. With that, let me now turn the call over to Tom.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Thank you, Dexter. Happy New Year, and thank you for joining our call today. The entire Lamb Weston team delivered another solid quarter, and I want to thank them for these results and continuing to execute the strategies that we outlined in our Investor Day presentation in October. We strongly believe that our investments to expand capacity organically and through acquisitions, improve manufacturing and system capabilities, penetrate new channels and markets around the world, strengthen product, customer, and channel mix, and develop our people, have generated good near-term operating momentum and have us well positioned to capture our share of growth and profitability over the long term. In the second quarter, we delivered record sales, reflecting the consolidation of our EMEA business and solid price mix growth. Sales volumes, excluding acquisitions, declined, primarily driven by our decision to exit lower price and lower margin business.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

But as we expect, the year-over-year trend improved sequentially. Adjusted EBITDA growth was also solid behind incremental earnings from consolidating EMEA, as well as higher sales and gross profit in the base business. However, the increase was tempered by a $71 million charge to write off excess raw potatoes, $65 million of which was recorded in cost of sales and $6 million in equity method investment earnings. The reason and magnitude of this charge is very unusual, so let me give you a little more color on it. In January 2023, we developed an initial sales forecast for the following fiscal year that reflected a gradually strengthening consumer and recovering global demand. That forecast was developed based on the information available at that time. We used this initial sales forecast to determine the number of contracted acres to grow the raw potatoes needed to deliver that sales forecast.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Per our agreements with our growers, we're obligated to purchase all the potatoes grown on these contracted acres. However, our initial sales forecast has turned out to be more aggressive than our current estimate, reflecting recent restaurant traffic and demand trends as consumers continue to absorb the cumulative effect of inflation. As a result, we have purchased more potatoes than we need to meet our current sales targets and have taken a charge to write off the estimated excess. Although overall, demand growth is slower than we anticipated a year ago, it remains resilient. Price attachment rates in the U.S. are stable and in line with what we projected in January 2023. Outside the U.S., restaurant traffic in most of our key international markets continues to grow, including double-digit growth in China.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

We remain confident that our volume trends will continue to improve in the back half of fiscal 2024 as we begin to lap and backfill exited volumes with higher-margin business. This includes our target for year-over-year volume growth in the fourth quarter. In addition, we expect our volumes will continue to recover in fiscal 2025 and have planned to contract for acres accordingly. While we are disappointed with the write-offs, the underlying fundamentals of the business, our operations in the category remain solid. Our volume trends are improving in line with our expectations. Global demand is resilient as consumers continue to face stiff food away from home inflation. Our new greenfield processing facility in China is now operational. Price mix trends in the U.S. and most of our key international markets remain solid, while input cost inflation is decelerating.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

We deliver strong adjusted EBITDA growth and gross margin expansion, excluding the potato write-off. As Bernadette will explain in greater detail, we're reaffirming our fiscal 2024 adjusted EBITDA guidance range despite absorbing the write-off while raising our EPS estimates. Overall, we continue to be pleased with our operating momentum and confident in our ability to deliver our full-year financial targets. Let me now turn the call over to Bernadette for a more detailed discussion on our second quarter results and updated outlook.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Thanks, Tom, and Happy New Year, everyone. I also want to start off by thanking the entire Lamb Weston team for the continued execution of our strategies and for delivering another quarter of strong financial results. For our second quarter, sales increased about $455 million, or 36%, to more than $1.7 billion. About $375 million, or more than 80% of the increase, was attributable to the incremental sales from the acquisition of the EMEA business. We'll continue to receive the incremental benefit from the consolidation of the EMEA business in the third quarter, and as a reminder, since we began to consolidate EMEA sales beginning in the fourth quarter of fiscal 2023, those results are included in our last year's sales baseline. Excluding the incremental sales from the EMEA acquisition, net sales grew 6%.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Price mix was up 12% as we continued to benefit from the inflation-driven pricing actions taken in fiscal 2023, along with the pricing actions taken this year in both our North America and International segments. Mix was also favorable as we continued to strategically manage our product and customer portfolio. Lower freight charges to customers were about a 1-point headwind. Total sales volumes declined 6%, which was in line with our expectations. The decline was primarily due to the carryover impact of exiting the lower margin business during the second half of fiscal 2023. Volume elasticities, or the amount of volume lost in response to inflation-based pricing actions, remain low. While sales volumes declined compared to the prior year period, it's a sequential improvement from the 8% decline that we delivered in our fiscal first quarter.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

The improving trend largely reflects no further impact of the inventory destocking in Asia and North America that we experienced in the first quarter, and the gradual backfilling of the business that we chose to exit. Moving on from sales, gross profit, excluding unrealized mark-to-market gains and losses related to derivatives and items impacting comparability, increased $97 million to nearly $480 million. Our gross profit growth was tempered by a $65 million charge for the write-off of excess raw potatoes. Excluding this charge, as well as the mark-to-market and comparability items, gross profit increased $162 million to more than $540 million.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

About half of this increase was driven by the cumulative benefit of pricing actions, mix improvement, and supply chain productivity in our legacy Lamb Weston business, which more than offset higher input and manufacturing cost per pound and the impact of lower volumes. The other half of the increase was from incremental earnings from consolidating EMEA. Input costs increased mid-single digits on a per-pound basis, which is a bit lower than the mid to high single digits that we saw in the first quarter. The increases were largely driven by a 20% increase in the contracted price for potatoes in North America, and continued increases in the cost of ingredients for batter coating, labor, and other key inputs. The inflation was partially offset by supply chain productivity savings, lower costs for edible oils, and lower freight costs.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

SG&A, excluding comparability items, increased $42 million to $177 million. More than two-thirds of the increase was from incremental SG&A, with the consolidation of EMEA, with the remainder largely driven by higher expenses related to improving our IT and ERP infrastructure, as well as compensation and benefit expenses. All of this led to Adjusted EBITDA increasing 15% to $377 million. Excluding the write-off for excess raw potatoes, Adjusted EBITDA increased 36% to $448 million. Higher sales and gross profit in the base business drove most of the growth, with the remainder attributable to the incremental earnings from consolidating EMEA. Moving to our segments. Sales in our North America segment, which includes sales to customers in all channels in the U.S., Canada, and Mexico, increased 10% in the quarter.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Price mix was up 14%, which was driven by the carryover benefit of pricing actions that took effect in fiscal 2023 across each of our primary sales channels, as well as some pricing actions taken this year, and favorable mix as we continue to benefit from our revenue growth management and other mix improvement initiatives. Lower freight revenue partially offset the increase by about 1.5 points. Volume in North America declined 4%, reflecting the carryover impact of exiting lower margin business during the second half of fiscal 2023. This is a sequential improvement from the 5% decline in our fiscal first quarter. North America segment Adjusted EBITDA increased 7% to $321 million.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

The carryover benefit of pricing actions and favorable mix more than offset a $63 million charge for the write-off of excess raw potatoes, higher costs per pound, and the impact of lower volumes. Sales in our international segment, which includes sales to customers in all channels outside of North America, grew about $350 million, of which $376 million were incremental sales from the EMEA acquisition. Excluding the EMEA acquisition, net sales declined 12%. Price mix was up 10%, driven primarily by the carryover benefit of pricing actions taken last year, discrete pricing actions taken this year, and favorable mix. Sales volumes fell 22%, which primarily reflecting the carryover impact of exiting the lower margin business during the second half of fiscal 2023.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

International segment adjusted EBITDA increased 66% to $100 million, with incremental earnings from the consolidation of EMEA's financial results driving the increase. Excluding the EMEA acquisition, higher cost per pound, along with the impact of lower volumes, more than offset the favorable price mix. The higher cost per pound included an $8 million charge allocated to the international segment for the write-off of excess raw potatoes, which was based on the percentage of finished goods shipments to international markets. Moving to our liquidity position and cash flow. Our balance sheet is strong. We ended the quarter with our net debt leverage at 2.4 times adjusted EBITDA, up from 2.3 times at the end of our fiscal first quarter.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Our net debt ticked up a couple hundred million dollars to more than $3.5 billion, as we drew on our U.S. revolver to largely finance seasonal working capital needs and increase capital expenditures. We also accelerated some payments to suppliers in advance of our ERP system go live at the beginning of the third quarter. In the first half of the year, we generated $455 million of cash from operations, or nearly $170 million more than the first half of last year, largely due to higher earnings. Capital expenditures in the first half were about $565 million, which is up about $300 million from the prior year period, primarily due to construction and equipment purchases as we continue to expand processing capacity in Idaho, Argentina, and the Netherlands.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

As Tom mentioned, we started up our new facility in China a couple of months ago. As we discussed during our Investor Day in October, our first priority is investing in our business, which we are doing organically with our capacity expansions. We also remain committed to returning capital to our shareholders. During the first half of the year, we returned more than $230 million of cash to our shareholders, comprised of $82 million in dividends and $150 million in share repurchases. This includes $50 million of stock repurchased in the second quarter at an average price of $87.41, as we acted opportunistically based on our stock price.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

In addition, in October, we raised our share repurchase authorization to $500 million, and in December, we announced a 29% increase in our quarterly dividend to $0.36 per share. Turning now to our fiscal 2024 outlook. We reaffirmed our full-year sales and EBITDA targets and raised our EPS estimate despite the charge to write off excess raw potatoes. Specifically, we reaffirmed our annual net sales target of $6.8 billion-$7 billion. This includes $1.1 billion-$1.2 billion of incremental sales attributable to the EMEA acquisition during the first three quarters of the year, and 6.5%-8.5% net sales growth, excluding our acquisitions.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

For the year, we continue to target price mix to be up low double digits, with price mix in the second half slowing sequentially from the 17% increase that we delivered in the first half as we lap more of last year's price actions. We continue to target our full year volume, excluding acquisitions, to be down mid-single digits compared with the prior year, as we maintain our cautious view of the consumer. That said, we expect year-over-year volume trends in each of our segments will continue to improve in the second half of the year as we lap some of the significant low margin, low profit volume that we chose to exit in the second half of last year, and as we gradually backfill the exited lower margin business with more profitable business. We expect volume growth to be positive in the fourth quarter.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

For earnings, we're reaffirming our adjusted EBITDA range to $1.54-$1.62 billion. We're maintaining our EBITDA range target despite absorbing a $71 million charge for the write-off of excess raw potatoes. We're raising our adjusted diluted EPS estimate to $5.70-$6.15 from our previous range of $5.50-$5.95. The increase, which also includes the impact of the raw potato write-off, is largely due to two items. First, we're reducing our SG&A target by $20 million to a range of $745-$755 million as we continue to manage our operating costs.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Second, we're reducing our interest expense target by $15 million to $140 million, as we expect to capitalize more interest associated with our capacity expansions. We're also updating a couple of other financial targets. We reduced our depreciation and amortization expense by $20 million to $305 million. We also increased our capital expenditures target to $900 million-$950 million, up from our previous estimate of $800 million-$900 million, to account for the timing of spending for our capacity expansion projects. Before I turn the call back over to Tom, let me give you a quick update on our ERP implementation. At the beginning of our fiscal third quarter, we transitioned some of our central systems in North America that manage supplier payments, inventories, warehousing, customer invoicing, and customer shipments to SAP.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

We're experiencing the usual bumps associated with these highly challenging, large-scale projects, but don't expect that the cutover will have a material impact on our full year business or operating results. The estimated financial impact of the systems go live is included in our fiscal 2024 targets, including the impact of pausing production and increasing planned downtime at our processing facilities, followed by a gradual ramp-up of production, and reduced shipments due to short-term inventory visibility challenges at our third-party finished goods warehouses in the period immediately following the cutover. As a result of the increased production downtime, our third quarter gross margin, which is typically our strongest, will be pressured by higher manufacturing costs, reflecting reduced fixed cost coverage and other cost inefficiencies.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

With respect to sales, we expect the inventory visibility challenges that we experienced at the third-party warehouses to affect shipments and temper the sequential improvement in our third quarter volume trends. But as I mentioned earlier, we continue to expect positive year-over-year volume growth in our fiscal fourth quarter. I want to thank our customers and our warehousing and logistics service partners for working with us to manage through the transition. Most importantly, I want to thank our Lamb Weston team members that have been working tirelessly on this project, including throughout the holiday season. We will provide a further update on the transition of the central systems and processes, as well as a general timeline for implementing the new ERP system throughout our manufacturing network during our third quarter earnings call in April.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

In summary, we delivered another strong quarter of top and bottom line growth as we continued to execute our strategies, manage our portfolio mix, and manage costs. We continue to expect volume trends to improve in the second half of the year, while remaining cautious about the effect of inflation on the consumer. And finally, we updated our earnings estimates for the year, including reaffirming our annual EBITDA range, despite absorbing a write-off for excess raw potatoes and raising our annual EPS estimates to reflect lower SG&A and interest expense. Let me now turn it back over to Tom for some closing comments.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Thank you, Bernadette. Let me sum it up by saying we feel good about the overall health of the global category and the drivers for demand growth. We also feel good about our operating momentum and are confident in our ability to deliver our updated financial targets for the year. And finally, we believe that our focus on executing our strategies will continue to have us well positioned to drive sustainable, profitable growth and create value for our shareholders over the long term. Thank you for joining us today, now we're ready to take your questions.

[Operator]

If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, that is star one if you would like to ask a question. We'll take our first question from Matt Smith with Stifel.

[Matt Smith, Director and Senior Equity Analyst at Stifel]

Hi, good morning.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Good morning, Matt.

[Matt Smith, Director and Senior Equity Analyst at Stifel]

I wanted to ask a question about your reiteration of guidance despite the $71 million potato charge. If you could talk about what led to the potato charge, it sounds like your initial contracted acres were based on your outlook from January of the past year. So have you changed your shipment volume expectations relative to the guidance that you initially provided us in July? And then with the excess potato charge, does that represent the full amount of excess potatoes, or were you able to utilize some of the higher-than-expected yields, either through processing finished goods or holding more raw potatoes into next year? And how does that impact how you go about contracting acres for next year based on your current expectation for volumes into next year?

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Yeah, Matt, thank you for the question. I think as it relates to the first one and it relates to guidance, the amount of shipments and volumes that we had in our guidance in July has not changed from what we have now. Again, that was, we had to determine the number of acres to plant back in January of 2023, but the last time we gave guidance, there's been no changes. And then the second question, as we think through the crop this year, there are mitigants that we would have taken into consideration in terms of carrying some higher finished goods inventory for products that we know that we're going to sell. And then, as we always do, we will take that into consideration as we determine the number of acres that we're going to plant for the upcoming year.

[Matt Smith, Director and Senior Equity Analyst at Stifel]

Thank you, Bernadette. And maybe as a follow-up, could you talk about how your contract negotiations are progressing with farmers into next year, given it sounds like maybe you're going to contract for fewer acres, how does that change the pricing conversation?

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Matt, this is Tom. You know, I'll as we do every year, we're right in the middle of negotiations, so we're not going to get into where we're at in that process. As we always do, in July, October, you know, we'll give you an overview of kind of where we ended up and talk about that in more detail. But right now, you know, we're right in the middle of it, so we're going to respect that process. Thank you, Tom and Bernadette, I'll pass it on.

[Operator]

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

[Adam Samuelson, Vice President at Goldman Sachs]

Hi. Yes, thank you. Good morning, everyone.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Good morning.

[Adam Samuelson, Vice President at Goldman Sachs]

Good morning. Just so on the charge, and I wanna just be clear as we think about otherwise, your gross profit margin in this quarter would have been 350 or so basis points higher, and your full year gross margins would have been the impact of the full year is about 100 basis, 90-100 basis points. And so as we think about the absence of this charge, assuming it wouldn't repeat in 2025, all else equal, your gross profit margins are tracking kind of pretty comfortably ahead of how you framed your business outlook at the investor day in October, or am I mischaracterizing that?

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Yeah. No, thanks, Adam. You know, you're correct. Our Q2 gross margins implies a 31.3% margin, excluding the write-off of the potatoes. And as we've been talking about, you know, that increase is related to the pricing actions and then catching up to the multi-year impact of inflation, and also allowing the benefit of the productivity and mix that falls through. So, those are some of the things that you're seeing. As it relates to the third quarter, keep in mind that it's gonna be down sequentially from that, and that's gonna reflect that reduced fixed cost coverage that we're gonna have as we started up our ERP, and we needed to take some downtime and ramp our plants up slowly.

[Adam Samuelson, Vice President at Goldman Sachs]

Okay, that, that's helpful. And then, maybe Tom or Bernadette, can you provide a little bit more detail on the progress on integrating EMEA? And just how do we think about where you are with that group on some of the revenue growth management tools that you've been implementing successfully in North America, and how kind of that business has been performing on an organic basis? Well, it'll start to be in the year-on-year comparisons organically in the fourth quarter. But just are you tracking ahead of where you thought, or what inning do you think those RGM tools are in terms of being deployed?

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Yeah, Adam, this is Tom, and I'll tell you, I'm really pleased on where we're at in terms of the integration of EMEA at this point. We're towards the tail end of that, and the team has done a terrific job across the organization, functionally, commercially, really connecting up. And, you know, we've reorganized the organization to reflect the global company that we are now, so I'm pleased with where we're at. In terms of initiatives, your specific question on RGM, that's definitely on the radar. But that's gonna be down the road based on, you know, a number of other initiatives we have going on in the company that we really need to keep our focus on executing, specifically the ERP implementation right now. So we're at the tail end of it, feel great.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

The team's doing a magnificent job getting integrated, and I'm pleased with where we're at today.

[Adam Samuelson, Vice President at Goldman Sachs]

Okay. Well, I appreciate the comment. I'll, I'll pass it on. Thanks.

[Operator]

We'll now take our next question from Robert Moskow with TD Cowen.

[Robert Moskow, Managing Director at TD Cowen]

Hi, thanks for the question. You know, a lot of other food industries, when raw material supplies far exceed what the demand expectations were, you know, you'd expect some impact on pricing, some negative impact on pricing, but your industry is not like a lot of those others. So Tom, maybe you could talk a little bit about, you know, your pricing power and the industry's pricing, and why, you know, the excess potatoes are not a concern.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Yeah, Robert, the thing to remember is, the commodity in our business, the potato, it's a one-year crop, and, you know, so you have to process it. And certainly, like Bernadette alluded to, we looked at all of the mitigating factors like we do every year. And, you know, it's just an unusual circumstances to the order of magnitude. Typically, we manage through different positions based on our forecast. And, you know, this year is different, and the crop overall is really, really good, and it's just a matter of, you know, you gotta make some decisions based on the demand forecast, utilizing your plants, running the crop longer.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

And economically, this was the best decision to move forward based on, you know, as we're going through the end of this crop and moving into the next crop in, you know, come June, July. So, it's a different, it's a different commodity. It has a shelf life that's rather short than a lot of the other commodity businesses I've been around. And so, you know, it's something we manage through every year. And unfortunately, how the operating environment and the environment with this particular crop shaped up, the quality of the crop, the yields just put a lot of pressure on availability, which, you know, there's plenty of potatoes around.

[Robert Moskow, Managing Director at TD Cowen]

Got it. Got it. I guess a follow-up. I think you said on the last call that about 20% of your North American.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Business was still in contract discussions. Is all that done now, and did you get the pricing that you expected to get in those discussions?

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Yeah. So the contract renewal process is complete now, and we feel really good about where, in the aggregate, we ended on both pricing and terms. You know, a lot of that relates to the large chain restaurants that we typically will finalize in the back half of the year, and that's what makes up that 20% that you're referencing.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Great. Okay, thank you.

[Operator]

We'll now take our next question from Rob Dickerson with Jefferies.

[Rob Dickerson, Managing Director at Jefferies]

Great. Sorry about that. Thank you. Yes, I just a quick clarification question. I wanna come back to the kind of sequential, I guess, implied gross margin trajectory for Q3. I guess it's more for Bernadette. I think you said, right, there are some plants that maybe were kind of are being shut down kind of temporarily, right, to implement some of the ERP initiatives. But then at the same time, right, Q3 is usually the highest gross margin quarter. And then at the same time, you know, we're comparing it to Q2, we're inclusive of the write-down, but then extra write-down or, like, closer to 31.

[Rob Dickerson, Managing Director at Jefferies]

So the very basic question with Lamb, the long build up was, you know, if you were saying that the gross margin would be down sequentially a little bit from the normalized gross margin in Q2, once we X out the inventory, is that how you were speaking to that?

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Yeah, exactly. So I'd say it's gonna be down sequentially from the 31%. That's excluding that write-off.

[Rob Dickerson, Managing Director at Jefferies]

Right.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

That's, you know, really reflecting the reduced fixed cost coverage that we're gonna have as a result of taking those plants down, while we cut over.

[Rob Dickerson, Managing Director at Jefferies]

Got it. And then in terms of the EBITDA margin, the same, same logic flows through?

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Absolutely.

[Rob Dickerson, Managing Director at Jefferies]

Okay, cool. And then I guess, you know, just back to the volume piece, you know, no change there. Still expected for volume to be down mid-single-digit for the year. I remember coming out of the last call, yeah, there were some questions around that because getting, like, down, like, real down, like mid, mid-single-digits, seem kind of challenging if we're thinking, you know, Q4 is up, even if it's up a little bit, and now we have the first half. So, you know, if we kind of put it all together and think, "Well, what about Q3?" You're still saying that kind of, you know, overall volume should improve year-over-year, sequentially relative to Q2, and then Q4 is up a little bit, that still gets you down to at least a 4% decline.

[Rob Dickerson, Managing Director at Jefferies]

I'm just asking that kind of in a detailed way, because, you know, it is kind of challenging to get down, you know, any more than, you know, 4%, right?

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Yeah.

[Rob Dickerson, Managing Director at Jefferies]

Just wondering.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

No, Rob. Yeah, so, so the way to look at it is, first, we're really pleased with what we're seeing from a volume perspective and the sequential improvement that we've continued to post. We will be positive in the fourth quarter, but the thing we've got to keep in mind is that we are having reduced shipments as a result of converting over to our new ERP. I spoke about the inventory visibility challenges that we've had with our third-party warehouses. I'm confident in that we're correcting those, but we are gonna temper our volume increases in the third quarter as a result of that.

[Rob Dickerson, Managing Director at Jefferies]

Okay. So kind of in theory, like, volumes could be down in Q3, maybe in a similar way relative to Q2, hopefully a little bit better. But there are a bunch of moving pieces that we shouldn't be expecting, like, a nice sequential improvement in Q3.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

That's right.

[Rob Dickerson, Managing Director at Jefferies]

Okay, cool. And then, thirdly, I just wanna touch on China quickly. Tom, I think you said China is growing double digit, kind of normalized, I guess, once we X out some of the business exits. You know, maybe just kind of touch on, you know, kind of overall environment in China, kind of what you're seeing, given all the news flow over the past few months. And then maybe just, if you could, touch on, you know, kind of your ability, let's say, to continue to partner with McDonald's over the next couple of years, clearly, as they look, you know, to really expand within the country. And that's it. Thank you.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Yeah, Rob. So, you know, as we stated earlier, that we're China's growing at double digits. You know, we're well-positioned. We've just opened up our second factory over there. It's up and running and operating. It gives us considerable flexibility as we're thinking about the next year's contracting coming up. And, you know, so we're. You know, there's a lot of news feed on China and the economy and all that, that's going on. But in terms of the category, you know, we feel good about where that's at. Based on the data we look at, which is telling us it's growing double digits. We've got our plant up and coming. We've got, you know, line of sight to how we're gonna, you know, look at that market and potential customers that we can support.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

You know, more to come on that, but, you know, as we go through this contracting season in that international market, we're well positioned to, you know, gain some business.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Yeah, and then.

[Rob Dickerson, Managing Director at Jefferies]

There's a.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Just to clarify, the double-digit growth is, has been in restaurant traffic that we're seeing in China?

[Rob Dickerson, Managing Director at Jefferies]

All right. Super. All right. That's all. Thanks, team.

[Operator]

Once again, that is star one, if you would like to ask a question. We'll now take our next question from Peter Galbo with Bank of America.

[Peter Galbo, Director at Bank of America]

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

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Good morning, Pete.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Morning, Pete.

[Peter Galbo, Director at Bank of America]

I guess just, you know, on the pricing front, obviously, you're going through some contract negotiations, but if I remember correctly, you have some contracts, I think, with your global customers that actually kicked in, you know, a couple of days ago, or I guess the start of Q3. So just can you remind us kind of what the dynamic looks like there, or that embedded price that we should be thinking about, price mix that we should be thinking about, in the back half of the year?

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Yeah. So, we did have some contracts where that pricing took effect in the back half of the year. I think it's key, though, to, as you look at the back half of the year, to expect to see a deceleration from the 17% that we delivered in the first half, as we continue to lap those price increases. But yes, we will see the impact of those contracts that are coming up, or are affecting our pricing in the back half of the year, just like we always have.

[Peter Galbo, Director at Bank of America]

Got it. Okay. Okay. And then, Tom, maybe just back to the Investor Day, I know there was a conversation around, you know, getting back to algorithm kind of in fiscal 25 and, you know, noting some of the volume challenges, you know, that you'll begin to lap by then and maybe into Q4. I mean, is that kind of still the expectation where we sit today relative to October, that as we get into 25, you know, the volume trends could at least get back to what you stated as kind of the long-term algorithm? Thanks very much.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Yeah, Peter, we fully expect to continue to drive and deliver our algorithm over the long term, as we stated in October, and, you know, we're working all the, the channels to deliver that. And as we have in the past, we've been very consistent on meeting those commitments. And I expect, and as we look forward, with the category and how we're getting positioned with some of the, the capacity additions, I fully expect us to, you know, drive volume and meet our commitments as we talked about in October.

[Peter Galbo, Director at Bank of America]

Great. Thanks very much, guys.

[Operator]

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

[Andrew Lazar, Managing Director at Barclays]

Great. Good morning, everybody.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Morning, Andrew.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Good morning.

[Andrew Lazar, Managing Director at Barclays]

I guess to start with, I was wondering if you're able to sort of help us quantify a little bit, maybe how much sort of volume gets pushed from Q3 to Q4 based on some of the cutover dynamics that you mentioned. I'm really trying to get a sense of about what, like, the underlying sort of volume picture looks like for Q4, particularly as it relates to as we move into next year.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Yeah, Andrew, I think the way to think about that is, you know, we're not going to quantify any amounts, but certainly, there are some shipments that would be retail and food service that would be lost in third quarter, whereas the chain would be more of a carryover. So again, so it's going to be tempered in terms of than any increase as it relates to volume in the third quarter, but definitely positive in the fourth quarter as we had originally projected.

[Andrew Lazar, Managing Director at Barclays]

If we excluded some of the cutover dynamics, do you think volume in 4Q would have been positive anyway, or maybe closer to flattish or even down a little bit? If maybe no-

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

No, absolutely, absolutely positive in the fourth quarter. That's what we've been anticipating since we gave our July guidance, and it continues to remain sound.

[Andrew Lazar, Managing Director at Barclays]

Great. Thanks for that. And then, Tom, I'm curious, you know, you obviously walked away from some lower-margin customers in the back half of last year that you're going to start to lap as we go into the back half of this year. And as you start to replace or start to add in new customers with some of the new capacity coming in, I'm curious, where, where were those. maybe some of these new customers that you're gaining, where were they, or have they been getting supply from before? And are you displacing, you know, others now that you have some capacity or. You know, I'm trying to get a sense of, because it doesn't seem like I've ever gone anywhere and not been able to get French fries.

[Andrew Lazar, Managing Director at Barclays]

I'm just wondering where some of these new customers were, you know, sourcing product maybe before you became a supplier to them, if that makes sense.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Yeah, Andrew, I understand the question. I'm not going to get into very specific on customers or where it's coming from, but you know, ideally, we have line of sight to markets, opportunities, you know, as we go through our normal contracting season coming up. Ideally, it'd be perfect timing, but it doesn't always match when you potentially win business. But we do have a plan, we have line of sight, and I'm not going to get into the specifics of where and who and with respect to our customers and I'll just leave it at that, Andrew.

[Andrew Lazar, Managing Director at Barclays]

Okay. Thank you.

[Operator]

A brief reminder, that is star one, if you would like to ask a question. We'll take our next question from Marc Torrente with Wells Fargo Securities.

[Marc Torrente, Vice President of Equity Research at Wells Fargo Securities]

Hey, good morning. Thanks for the question. It sounds like trends are a little softer than the initial plan from January of 2023, but you noted demand remains solid relative to the initial guide. Could you maybe reconcile some of that commentary out to some of those trends and traffic that you're seeing that gives you confidence on, volumes improving on an underlying basis?

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Yeah, you know, as I stated. You know, the crop acres, potato yields, based on what we always planned for, in the initial front end of the crop cycle, certainly was, you know, better than what we expected and have seen the last several years. And the overall forecast, as I stated earlier, that we had in terms of overall volume and sales, you know, was a little softer than what we had originally planned. As we've been consistent, the guidance we gave in July and continue and, you know, we upped it in October, was based on the forecast we were seeing at the time. And so certainly there's, it was not as good as we had planned when we planted the crop.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

But again, to Bernadette, she reiterated, we see our forecast from July in terms of sales and volume has not really changed for the balance of the year. So it's really just a crop acre yield issue that caused a write-off based on what we initially forecasted in July for the FY 2024. So again, we feel confident about the underlying fundamentals of the business. Where we're at, our guidance from last time has not changed, and, you know, we see line of sight to Q4 volume improving as we've stated on this call. So, you know, all things are pointing towards sequential improvement for the balance of the year, albeit just keep in mind that Q3 is gonna have some challenges with the ERP cutover.

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

Yeah, and Tom, if I could add to that, you know, when we made the initial estimate and planted those acres, you guys see the same data that we do, and U.S. restaurant traffic trends have slowed since that time, and that was included in our updated July forecast. But the fry attachment rate continues to be above pre-pandemic levels and continues to be strong as Tom mentioned.

[Marc Torrente, Vice President of Equity Research at Wells Fargo Securities]

Okay, great. That makes sense. Then, you lowered the SG&A outlook for the year. A little more color here. Is that timing around some of those special projects? Are you pulling back on any of the underlying expenses, or is that better leverage on core?

[Bernadette Madarieta, Chief Financial Officer at Lamb Weston]

You know, it's gonna be some better leverage, but just overall cost management that we're doing as we look forward to the second half of the year.

[Marc Torrente, Vice President of Equity Research at Wells Fargo Securities]

Okay, great. Thank you.

[Operator]

That does conclude our question and answer session. I'd like to turn the conference back over to Mr. Congbalay for any additional or closing comments.

[Tom Werner, President and Chief Executive Officer at Lamb Weston]

Thanks, everyone, for joining the call today. Any follow-up discussions, you know, please send me an email, we can schedule some time. Other than that, have a great day and Happy New Year. Thank you.

[Operator]

Once again, that does conclude today's conference. We thank you all for your participation. You may now disconnect.

Participants

Executives

• Bernadette Madarieta, Chief Financial Officer
• Dexter Congbalay, Vice President of Investor Relations
• Tom Werner, President and Chief Executive Officer

Analysts

• Matt Smith, Director and Senior Equity Analyst at Stifel
• Adam Samuelson, Vice President at Goldman Sachs
• Robert Moskow, Managing Director at TD Cowen
• Rob Dickerson, Managing Director at Jefferies
• Peter Galbo, Director at Bank of America
• Andrew Lazar, Managing Director at Barclays
• Marc Torrente, Vice President of Equity Research at Wells Fargo Securities