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

Good morning, and thank you for joining us for Lamb Weston's second quarter 2023 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. Tom will provide an overview of the current operating environment, while Bernadette will provide details on our second quarter results and our updated fiscal 2023 outlook. With that, let me now turn the call over to Tom.

Thank you, Dexter. Good morning. Happy New Year and thank you for joining our call today. We're pleased with our financial performance in the second quarter as we continue to drive strong sales and earnings growth across each of our core segments. Our results reflect the successful execution of our strategies to counter the significant input cost inflation over the past couple of years through a combination of pricing actions, improving business and product mix and adapting our manufacturing and supply chain to global challenges. Specifically, we delivered sales of nearly $1.3 billion, a record high quarter, healthy gross margins in each of our core business segments and strong earnings EBITDA and earnings per share growth. Because of our first half results and confidence in our business momentum, we've increased our sales, gross margin and earnings targets for fiscal 2023. I'm proud of our performance in the first half of the year and how the entire Lamb Weston team continues to focus on serving our customers and driving sustainable, profitable growth. Before turning the call over to Bernadette, let me first provide some quick updates on the current operating environment. First, overall French fry demand in the U.S. remained solid although the total restaurant traffic remains below pre-pandemic levels. It's up versus the prior year quarter, and trends are up sequentially off the lows we saw in the summer, as gasoline prices spiked. Demand and traffic trends in the quarter varied by channel, as consumers reacted to broad-based inflation and the threat of a recession. QSR traffic was up versus the prior year, and trends improved sequentially versus our fiscal first quarter as consumers adjusted to less expensive dining options. As expected, casual dining and full-service restaurant traffic in the quarter was down versus the prior year, although trends also…

Thanks, Tom, and good morning, everyone. As Tom said, we're pleased with our financial performance and operating momentum through the first half of the year, which has provided us with a strong foundation to raise our annual sales and earnings targets. Let me review our second quarter results before discussing our updated outlook. Sales in the second quarter grew 27% to nearly $1.28 billion. That's a record for us. A 30% increase in price mix drove our sales growth as we continued to benefit from product and great pricing actions across each of our business segments. The increase reflects the carryover impact of product pricing actions that we initiated in fiscal 2022 as well as pricing actions that we began implementing during this fiscal year. The increase also reflects benefits from efforts to improve our portfolio mix. Sales volumes declined 3%, as we continued to experience the supply chain constraints and related shortfalls in order fulfillment that Tom described. This primarily affected volumes and service levels in our Foodservice and Retail segments. To a lesser extent, volumes in the quarter were also impacted by softer casual dining and full-service restaurant traffic as well as the timing of replacing losses of some low-margin business in our Foodservice and Retail segments. Gross profit in the quarter increased $176 million to $382 million, as a result of our sales growth and strong gross margin performance. Our margin expanded 950 basis points versus the prior year quarter and about 550 basis points sequentially to nearly 30%. Broadly speaking, pricing actions in each of our business segments, efforts to improve customer and product mix, and value created from our productivity programs have caught up to the cumulative effect of input and transportation cost inflation over the past couple of years. Input cost inflation, however, continues…

Thanks, Bernadette. Let me sum it up by saying we're confident in our strategies and business momentum. And as a result, we've significantly increased our financial targets for the year. And we're also confident about the health and prospects of the category. And we believe that our capacity expansion and infrastructure investments will have us well positioned to support sustainable, profitable growth and create value for our shareholders over the long-term. Once again, I want to thank the entire Lamb Weston team for our success this quarter and their ongoing commitment to meet the needs of our customers. Thank you for joining our call today, and now we're ready to take your questions.

[Operator Instructions] Our first question is going to come from Tom Palmer from JPMorgan. Please go ahead, sir.

Good morning. And Congratulations on the quarter.

Good morning, Tom.

Good morning. Just kick off getting maybe a little color on the inflation outlook. I appreciate the comments in the prepared remarks. The release referenced double-digit inflation. It sounds like there's some moving parts, especially with potatoes stepping up in the second half, but you'll also be lapping some higher rates of inflation. So is the messaging that the absolute rate of inflation will step up in the second half of the year? Or would it be more comparable to what we saw in the second quarter?

Yeah. Thanks, Tom. This is Bernadette. We don't expect the absolute rate to increase. We will, though, however, continue to see that double-digit inflation for the remainder of the year. And as you said, that's reflecting the higher cost for potatoes and then other key inputs for edible oils, labor and ingredients. So absolutely expect that double-digit cost increase to continue but not increase.

Okay. Thank you. And then the bounce back in Europe. Where are we in kind of the return to normal? I mean did we exit the second quarter, what you would call, a normal earnings run-rate for that business? Is there still more work to be done? And as we think about the second half, should we look for another step-up in kind of the earnings power of that business as more pricing takes hold?

Yeah, Tom. So this is Tom. The team in Lamb Weston/Meijer soon to be Lamb Weston has made terrific progress. Marc Schroeder leads that business, and the business has turned the corner. They've implemented a number of actions to stabilize the earnings of that business as we expected. They're showing great progress. And the run-rates are trending positively, and we expect that to continue for the back half of the year. And as we close that transaction, as we stated, we expect that to happen in Q4 to get through all the reviews and regulatory process. We'll provide some more color on that once the transaction is closed in the coming quarters.

Okay. Thank you.

And our next question is going to come from Peter Galbo from Bank of America.

Hey, guys. Happy New Year. Thanks for taking the questions. Good morning.

Good morning.

Tom, I was wondering if you could just provide a little bit more context around your comment now that the company is sourcing some potatoes, I think, from the East Coast you mentioned. Just kind of maybe where you're seeing that relative to last year, I know when you had to source a decent number from the East Coast? And then anything just in terms of your plant network. Is there ability to move those potatoes not all the way to the basin, can you process them through the JV in Minnesota? Can you process them through the Delhi plant? Just any additional color would be helpful. Thanks.

Yeah. So the year-over-year this year, it's not as pronounced as it was last year because of the quality of the crop last year and yields. We got out ahead of it, the ag team in Lamb Weston has done a terrific job sourcing potatoes to meet our needs. They're still high cost. You got to freight them across the country and you have some quality issues when you're trucking that far. But it's not as pronounced as it was last year. And all those costs are reflected in our outlook for the remainder of this fiscal year. And good news, bad news is we had some experience last year, so we were able to rally quickly, and we understand how that all is going to impact the business. But again, that's all forecasted in our outlook. So we're doing everything we can to meet our customer demand, and that's the most important thing.

Got it. That's helpful. And Bernadette, I just had 1 clarification on the gross margin commentary for the back half of the year. I think you're still expecting a sequential improvement in 3Q, obviously, not as pronounced as it would have been historically but it would still improve in 3Q? And then is there a step down to expect in the fourth quarter? I just wanted to clarify those two things. Thanks very much.

Yeah. No, thank you. We do expect to see an increase. But as you said, it will not be as pronounced in the third quarter as we've historically seen. And then there will be a step down in fourth quarter, but again, not as pronounced as what we've historically seen.

Got it. Thanks very much, guys.

Yep, thank you.

And our next question is going to come from Chris Growe from Stifel.

Thank you. Good morning.

Good morning, Chris.

Hi. Happy New Year. Hi. Just a bit of a follow-on to that Peter's question and some of your response there. I guess just to understand the gross margin this quarter. I just want to get a sense of how unique the performance was this quarter. And I was sticking around the areas of like mix and perhaps even like limited time offerings to what degree that's influencing the gross margin this quarter that may not be sustainable? And then to what degree you're walking away from lower-margin business, and to what degree that's influencing your margin as well, perhaps there's other issues, too. But those are a couple of things I was thinking about just to get a little sense around and how that could affect the gross margin going forward.

Yeah. No, thank you for that question. And as it relates to the gross margin going forward, LTOs, there isn't anything unusual that we would have experienced this quarter relative to prior quarters or going forward. Really, what you're seeing is that we were able to pull forward a lot of the pricing actions in Global earlier than expected. And then we're going to be lapping some of the Foodservice and Retail price increases in the back half of the year. So there'll be more of a muted effect related to that. So a combination of the higher potato costs, the inflation and then the deceleration of that price/mix growth, that's what you're going to see have an effect on those margins in the back half of the year.

Okay. Thank you for that. And actually, I have a follow-on to that, which just be that you talked about pulling forward some of those global contract renewal discussions. So it sounds like you had a good renewal from this past summer, and that should start to kick in now. But it sounds like you also then pulled forward some -- maybe some from next summer. -- or even summers ahead. I guess just to get a sense of where you are then on contract renewals normally. It's like a third every year. Did you -- were you able to get more of that done is the question?

Yeah. We were able to go out and have conversations with our customers and pull more of that forward than had been anticipated, more than what we would have typically seen with our contract renewals. So we expect that the global pricing will remain strong in the back half. It's just we've been able to pull that forward earlier than expected.

And can you say how much of your contract renewals, how much more you've done this year? Or how much less you'll have for you going forward?

No, I can't really speak to that. I'd say, overall, we've got probably about 25% that we'll need to continue to renegotiate.

Okay.

But again --

Thanks so much.

That's based on pounds and not based on business or dollars.

Okay, great. Thank you for that.

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

Yes, thank you. Good morning, everyone.

Good morning, Adam.

Good morning.

Good morning. So I guess first question maybe on the demand environment. Some of this was in the prepared remarks, but I'd love to just hear you expand a little bit on just maybe different parts of Global between the domestic QSRs versus international? Foodservice traffic trends? And just as your customers absorb some pretty sizable kind of price increases, just the confidence that you don't see any changes in fry attach rates from the consumption perspective.

Yeah, Adam, overall, I feel really strong about the health of the category. And we've purposely had to make choices across our segments to support our customer base, and we've really focused on product/mix management across the portfolio and the customers. So the QSR segment continues to be really healthy. As we stated in our prepared remarks, the fast casual, casual dining is experiencing some weaker traffic. Although it's improving versus where it was in the first quarter, but we're also making choices and in terms of customer and supporting customers based on product mix and our capacity. And there are still challenges within our network to produce and get back to the levels where we were pre-pandemic. And the team, the supply chain team is working on that. And it's going to take us the balance of this year to continue to focus on things to improve that. So the category is healthy. And yes, our volume is a little soft in some areas. That's traffic driven. But over the long-term, when I look at the category and think about the next two, three, five years, and the investments we're making, we're going to be well positioned in a couple of years to bring on capacity and drive opportunities that right now we're making choices that we don't necessarily like we got to support our key customers going forward.

Yeah. And just to add to that, Tom, in addition to the softness that we have in the casual dining. More of that softness though is just related to the supply chain constraints that we've been experiencing. But overall, absolutely, our demand has returned to the pre-pandemic levels on a run-rate basis prior to what we saw with war in Ukraine.

Got it. And if I could maybe follow on the point on just capacity a little bit. You talked earlier about some of the product/mix impacting kind of throughput rates and kind of what you could actually produce from an end product perspective? I mean, do you think with the current product mix, if you were properly staffed and there wasn't raw material constraint around potatoes that the current capacity with this mix could produce the same volume of finished product that you did pre-pandemic? Or does the actual mix that you've kind of shifted to as it stands right now actually constrain your -- physically constrain your output going forward?

Yeah, Adam, so I know the team is working on getting to pre-pandemic levels, but the reality is the choices and the mix that we're now producing really oversimplifying it, we have to slow lines down when we're making coated product. So we can't run as fast. And so, there is some capacity disadvantages to running premium products. That's just a fact. However, I think the mix of the portfolio bodes well going forward for the profitability of the company.

Okay. And maybe just a final, if I could squeeze in. Of your total price/mix in the quarter, how much was mix? Can you share if you can -- or any reframing?

Yeah. We don't break the out mix from price, Adam. It's predominantly price.

All right. Okay, I just try. I appreciate all the color. I'll pass it on. Thanks.

Our next question will come from William Reuter from Bank of America. Please go ahead.

Hi. I just have two. Given the changes in your sourcing from the West Coast to the East Coast that you did last year now again this year, do you anticipate that in future years, if we return to more typical yields, you'll be able to shift that back to the West Coast and therefore, there should be some kind of margin expansion in 2024 and beyond?

Yes. I expect next year's crop to be normalized and then yields good and all the things that we're historically used to. And in terms of is that going to provide margin expansion? No, it won't. Materially, it won't. We're going to have inflation in our commodity costs next year. Again, I believe based on how the commodity markets are shaping up. And as I stated in the prepared remarks, where the potato crop negotiations, we settled with Pacific Northwest, you're going to be up 20% next year. And you stack that up over two years, that's a big lift. And it's going to be another difficult year, and we'll continue to adjust our thinking on pricing that through the market going forward, but it's not going to be material margin impact year-over-year just based on sourcing out of the East Coast.

Got it. And then my second is based upon your guidance, even pro forma for the acquisition of the rest of the joint venture, you're still going to be below your leverage target of 3.5 times to 4 times, you're going to be, I think, in the high twos. I guess what is that, I mean, in terms of capital allocation. I know you increased the dividend, but how are you thinking about that?

Yeah. No, we're excited about increasing the dividend based on our performance. As we think about capital allocation, we have not changed our priorities in terms of investing in the business for the long term. M&A, if there's M&A that's available and then we will reward our shareholders as well. But certainly, we're going to invest in the business first.

Okay. So the leverage target remains at 3.5 times to 4 times?

It does remain in that range. And as we've said before, we're doing that because we want to make sure that we have enough financial firepower for M&A or other items that may come up.

Got it. All right. That's all for me. Thank you.

Thank you.

There are no further questions at this time. I'd like to turn the conference back over to you, Dexter Congbalay for any additional remarks.

Thanks for joining the call this morning. If you want to have any follow-up sessions, please e-mail me so we can spend time and happy New Year, and have a good day. Thank you.

This concludes today's call. We appreciate your participation. You may now disconnect.