Lamb Weston Holdings, Inc.
Q2 2021 Earnings Call Transcript

Published: 7 Jan 2021

[Operator:]

Good day, and welcome to the Lamb Weston Second Quarter 2021 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Dexter Congbalay, VP, Investor Relations of Lamb Weston. Please go ahead.

[Dexter Congbalay:]

Good morning, and thank you for joining us for Lamb Weston's second quarter 2021 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.

[Tom Werner:]

Thank you, Dexter. Good morning, and thank you for joining our call today. We delivered solid financial results in the second quarter as our entire Lamb Weston team continues to execute well through this challenging environment. That's only possible because of their ongoing commitment to serving our customers, suppliers and communities. And I can't thank them enough for their dedication and support. Our second quarter results also reflect operating conditions that were generally similar to what we experienced in the first quarter. Overall restaurant traffic in the U.S. was resilient quite holding steady at around 90% of pre-pandemic levels for much of the quarter. However, traffic and frozen potato demand rates continued to vary widely by channel. Traffic at large chain restaurants were essentially at prior year levels as quick service restaurants continued to leverage drive-through, takeout and delivery formats. Traffic at full service restaurants was 70% to 80% of the prior year levels for much of the quarter. However, traffic began to soften in November as governments reimpose social and on-premise dining restrictions in an effort to contain the resurgence of COVID and as the onset of colder weather tempered outdoor dining opportunities across many markets. Traffic and demand at non-commercial customers, which includes lodging, hospitality, healthcare, schools and universities, sports and entertainment, and workplace environment was fairly steady at around 50% of prior year levels for the entire quarter. In retail, consumer demand continued to be strong with weekly category volume growth between 15% and 20% versus the prior year. Outside the U.S., restaurant traffic in fry demand were uneven across markets and varied within the quarter.

[Rob McNutt:]

Thanks, Tom. Good morning, everyone. As Tom noted, we delivered solid financial results in the second quarter, as our teams continued to manage through an ever-changing demand environment as well as COVID-related disruptions to our manufacturing and distribution networks. For the quarter, net sales declined 12% to $896 million. Sales volume was down 14%, largely due to fry demand at restaurants and foodservice being negatively impacted following government imposed restrictions to contain the spread of COVID, as well as colder weather beginning to limit outdoor dining across many of our markets. In addition, volume was down as we lap the benefit of additional shipping days related to the timing of Thanksgiving of last year. Overall, as Tom described earlier, restaurant traffic and our sales volumes in the U.S. stabilized at approximately 90% of pre-pandemic levels, although performance varied widely by sales channel. International sales were mixed but improved sequentially versus our first quarter. Price mix increased 2%, driven by improved price in our Foodservice and Retail segments as well as favorable mix in retail. Gross profit declined $62 million as lower sales and higher manufacturing costs more than offset the benefit of favorable price mix and productivity savings. As we discussed in our previous earnings call, we expect that our manufacturing cost to increase in the quarter. This was partly due to processing potatoes from the 2019 crop through early September, which is a couple of months longer than usual. We did this in order to manage finished goods inventories in light of the pandemics impact on fry demand. Processing older crop results in increased cost due to significant - due to higher raw material storage fees and lower recovery rates. Since we typically carry upwards of 60 days of finished goods inventory, we realize the impact of these costs in our second quarter income statement as we sold that inventory.

[Tom Werner:]

Thanks Rob. Let me just quickly sum up by saying while the near-term environment will be volatile. We believe that the restaurant traffic will gradually recover to pre-pandemic levels by the end of calendar 2021. We'll continue to focus on the right strategic and operating priorities to serve our customers and build upon the long-term health of the category in order to create value for our stakeholders. Thank you for joining us today and we're now ready to take your questions.

[Operator:]

Thank you. We can take our first question from Andrew Lazar of Barclays. Please go ahead.

[Andrew Lazar:]

Good morning, everybody, and Happy New Year.

[Tom Werner:]

Good morning, Andrew. Happy New Year.

[Andrew Lazar:]

Two questions from me, if I could. First, with visibility to getting back to pre-pandemic levels of demand by calendar year-end. I'm curious if there are any signs you were seeing of any lasting shifts in competitive dynamics among sort of the key North American players that could result in Lamb Weston coming out of this in a stronger relative position than it went in?

[Tom Werner:]

Yes, Andrew. So I think, right now, the industry - we're all navigating through the pandemic. And from Lamb Weston standpoint, our strategy has not changed. And while we have paused a few things that we are thinking about pre-pandemic, I will tell you that we're actively engaged in some projects and it's all of our positioning this company, as we believe the demand is going to return by calendar year. And if you think about 18 months from now, we got to be ready to capture share demand across the whole globe. So while we have paused a few things, we have reengaged in some things, projects that we are working on and we're going to move those forward to get ourselves in position 12 months to 18 months from now to capture the demand that we believe is going to come back to pre-pandemic levels.

[Andrew Lazar:]

That's a good segue into my second question which is, I know it's an odd time in some regards to ask about incremental industry capacity. But if you see frozen potato demand approaching pre-pandemic levels again by calendar year-end and then assuming demand globally grows it normalized levels from there, and knowing, it takes a few years to get new capacity for the industry online. When would you think we might hear of new industry capacity additions being announced whether that would be Lamb Weston or others?

[Tom Werner:]

Yes. One of our competitors, they're in the process of expanding capacity that they were working on pre-pandemic. From our standpoint, again, we've got some things that we're moving forward and the right time and we'll do all the work around it. We will make that decision. The other thing that - one of the silver linings with all this is, we've really focused internally on our efficiency and operating efficiencies within our current footprint. And it's giving us visibility to opportunities we believe within the current manufacturing footprint to unlock capacity. So that's something that the supply chain team in Lamb Weston is focused on. We have a big initiative within supply chain to unlock capacity and drive efficiencies. And if you think about, Andrew, the timing of new capacity versus what we have in our current footprint, I'm not 100% confident that with our supply chain initiative unlock, hidden capacity in our current footprint that we're absolutely in a great position as demand returns to support not only our current customers as their business returns, but also future demand and category growth. So I feel we're really in a position. But again at the right time, we got to make those decisions in terms of getting ourselves ready for demand resurgence 18 months, 24 months out.

[Andrew Lazar:]

Great. Thanks for your time.

[Tom Werner:]

Yep.

[Operator:]

And we can now take our next question from Adam Samuelson of Goldman Sachs. Please go ahead.

[Adam Samuelson:]

Yes, thanks. Good morning, everyone.

[Tom Werner:]

Good morning, Adam.

[Rob McNutt:]

Good morning, Adam.

[Adam Samuelson:]

Good morning. Hi. So I guess my first question is really related to some of the pricing comments that you made earlier and just some of where you're seeing some of that incremental competitive activity. Internationally, is that - I presume that's in your export markets out of the U.S. not in the European JV. But is that European competitors who are looking up to push into Asia? Just help me think about kind of – frame kind of where you're seeing that. And is that places they haven't played before? And then in domestically in the value-tier side, is that just European imports into the East Coast? How do you think about the origin of that competitive threat and kind of how salient and how much your volumes are really kind of framing in the exposure there?

[Rob McNutt:]

Yes, Adam, this is Rob. In terms of the pricing internationally, it is a mix of where that's coming from, the competitive, some of that in some markets where there is some of that lower end production is coming from local producers just run in the cash flow and some of it is coming from excess capacity in Europe. Similarly, in the U.S., again, it's in that lower end value market and we have seen some increases from the Europeans. That is certainly having some impact in that limited part of the market.

[Adam Samuelson:]

And just anyway, Tom, you could help think about just how much of that – of your business is really in those kind of categories where you're seeing. I’m just trying to contextualize kind of pockets where there is some - a little bit of competitive intensity?

[Tom Werner:]

Yes. We don't necessarily disclose that. But to Rob's point, it's the lower line flow, what we call it, so it's really not a material piece of our business. The point is, it's more pronounced in Asia and the Europeans are being competitive in Asia and it's not one market, specifically, it's random markets in Asia and our teams did a good job trying to hold serve. But when you get no situations, customers are going to think about going to different direction. But we're watching it closely. It is more pronounced than it has been, but I will say, it's nothing that we're not used to dealing with. It's just more aggressive. And the team will work through it and capture opportunities where we can.

[Adam Samuelson:]

Okay, that’s really helpful. And then, just my second one was going to be and I think about the fiscal third quarter and kind of volumes, kind of slowing down from where they were, I mean, it seems - seemingly a little bit more orderly than you might have been in the spring. I'm just trying to make sure, I'm sensitive and thinking about the gross margin kind of implications of softer volumes in the near-term. And just kind of the levers you can pull or just the ability to plan better to manage that kind of lower volume near-term?

[Tom Werner:]

Yes. I'll talk to this patterns and Rob you can hit the margin. If you think back through the initial start of the whole pandemic, our business evaporated. We’re down 60% in total, 50%, 60%. So as we look over this next quarter, while we're seeing softness in some of the channels specifically foodservice. I don't believe it's going to be anywhere near was when all these things started. Now that said, we gave guidance on what's happening through December. And I think that's going to be where it plays out over the next 30, 60 days we get winter things are open it back up. The most important thing for us to be prepared for the opening back up and we learned a lot of lessons last spring, as a management team and myself personally that we have to be ready. And what does that mean, it means if you think about April, May make - we're taking some measures right now to ensure we've got the right inventory, the right products, so wind demand snaps back, which we believe it will in the spring and start increasing we can service our customers. All the while recognize that we're still dealing with manufacturing operating issues because of COVID in terms of efficiencies. So on the one hand while, so things are slowing down in some areas. On the other hand, it's a great opportunity for us to get ourselves positioned to meet demand on this thing snaps back. So the near term is going to be volatile, but as we come out, get in the spring and summer, and you got vaccines and this thing hopefully starts getting behind us. I believe there's going to be some pent-up demand for people to get out, go out again. And so we're going to be prepared for that.

[Operator:]

We can now take our next question from Rob Dickerson of Jefferies. Please go ahead.

[Rob Dickerson:]

So just to kind of circle back, couple of comments you made on kind of where you are now in terms of, with your inventories and kind of how you have to be ready, right for potential demand snap back in, that's called April, May and June, whatever it is? Like, how do you feel, I guess for around or about Lamb Weston's kind of current inventory levels, and maybe the industry's inventory levels kind of B2B, right some of this kind of hopefully temporary softness in the Q3 and part of the business, right or is there like, if you step back, you say okay? This is where we are now. It's only potatoes we have, it's how many potatoes the industry has? I feel like we kind of see the forecast that somewhat appropriately relative to demand when we go back to raise March, April's of last year. And now as you said here do you think about Q3 into the spring and summer, do you kind of say, yeah, we still feel pretty good. The industry feels pretty good about this inventory levels as long as that demand does snap back. So we're now once again, kind of, so to speak over inventory is that fair?

[Tom Werner:]

Yes. I think my point of view is, I believe the industry's balance from Lamb Weston standpoint where we're balanced. I feel good about where we're at on raw availability and what we have in storage to meet the needs, Even if there is demand, I think we're in good shape. The thing that we're working on right now is to make sure we got the right inventory levels of product that was really pulled when the economy open back in May, June. And so we've got data and we can look and see what the customers, the products they were, we were shipping to all, so we're positioning those products to have a different level of safety stock, if you will to anticipate that. And I think we're in good shape from finished good inventory raw inventory. The thing to remember is the timing of whether it's April-May or June, the timing of consumer demand going out to eat more or maybe it's further down the road, we will manage it and we can manage our production schedules, we can manage inventory levels. So those things we could do and have done it, always do just to manage the supply and demand side of it. And so I feel good about where we're at. Now, like I said, we're getting ourselves prepared for demand returns as we get through Q3, and I think the company of being in shape and will react as needed just based on the ordering signals we're getting from our customers.

[Rob McNutt:]

Yes. Rob, the other point, I'd make or the distinction, initially when the pandemic first hit demand it - it's felt like when I have perfect insight into the downstream distribution through the channel, but it felt like they were working with old models and so the orders continue to come even as an end-user demand was coming off. We're seeing a quicker adjustment in that now. And so I think as we've learned, they've also learned and so that I'm not concerned about downstream channel being overloaded.

[Rob Dickerson:]

And then this might be too specific of a modeling question, like shot, your Global division right organic sales declined 12%, but two year stack basis like given we actually shipping days, maybe some LTOs is essentially flat, right? So that's pretty good all things considered. I'd argue, if I'm thinking about Q3, right, you don't have that big tough compare, so to speak on the volume side, then the speaking to global. So is there like, should we be thinking on the global side that it's sales the trajectory of that year-over-year should in theory really improve right assuming that shipments are still due to a pretty good relative to pre-pandemic because it kind of, it feels like we kind of all run a model down still, but obviously the year-ago does matter. So just any color on that would be helpful. Thanks.

[Tom Werner:]

Yes. I would say that in the QSR side, the big QSRs that demand seems to be just fine there. They figured out the model, and they're leveraging the drive-throughs and so forth. And there are other parts of that business, that sell to more sit-down restaurants and that's going to continue to look like our Foodservice. And then, in our international sales, okay, again that varies by country. We cited China and Australia being relatively strong, but there are some other international locations, which aren't strong. European to take you now, recognize Europe's not in our sales line. It's down in the equity earnings. And so, in Europe, the QSR don't have to drive through, so we'll have some headwinds there just because they don't have the same model.

[Rob Dickerson:]

And then just lastly very quickly, so if I kind of have to ask the past month or so, I think a lot of investors kind of come to and sale we've heard there might have been some contract pressure over the larger QSR domestically. I have no evidence of that from here you speaking to it sounds like things are pretty good, so to speak and what I'm hearing, so kind of give you the opportunity to address that so I just asked, because we've had - so many people asked me, is there any contract pressure in any larger QSRs? That's all. Thanks.

[Tom Werner:]

Yes. We don't specifically talk about customers and negotiations. What I will tell you is just like every other year we go through contract season with our customers, so to speak. And just like last year, just like the year before, this year we kind of came through as we expected and so that's generally where we ended up.

[Operator:]

And we can now take our next question from Tom Palmer of JPMorgan. Please go ahead.

[Tom Palmer:]

Good morning and thanks for all the detail on current trends. In the press release and in the prepared remarks, you mentioned your view that the overall frozen potato industry demand could approach pre-pandemic levels by the end of this calendar year. I just wanted to clarify, how this would have quite a Lamb Weston would you assume that the company's sales trends would be comparable to the overall industry? Or are there reasons why you might diverged from the industry, either because of a different channel mix than the industry or because of some customer wins or loses that have been taken place?

[Rob McNutt:]

This is Rob. In terms of our overall performance again, the Foodservice business, that's where we expect to see the snapback. As we talked about the QSRs have largely kind of held their own. So really in the Foodservice is where we'll see a lot of that strength. And so, and then some of those international markets where we've talked about that has been a little more challenge. And so those are the areas where we think we'll see the strength. And again, as Tom talked about in terms of the capacity unlock that supply chain team is working on, while we haven't spent the capital for a new line per se. The guys are figuring out some ways to get some capital out. So if you think about that, the ability to service that capacity. I think our international sales team is well set up and well positioned. And we've talked about our Foodservice sales team with that direct sales model movement to being in a favored position relative to maybe some of our competitors who are more broker oriented that adjusted their service model, a little bit cost of that and so we do feel good that we'll have relative opportunities.

[Tom Palmer:]

So just to clarify what you mean by that is, you think you could either grow with the industry, if not better when you say return to pre-pandemic?

[Tom Werner:]

Exactly.

[Tom Palmer:]

And then just wanted to ask, you wrapped up prepared remarks with the commentary on contract renegotiations. I just wanted to clarify exactly what this means. So if you're saying that the contracts that were renegotiated this year were flat and then should we assume that the contracts that kind of rollover have the typical price increases that are normally baked into them. And so kind of the net-net of your contract basket would be positive or do you mean the net-net would be flattish?

[Tom Werner:]

Well, the contracts, as I stated earlier were - that we talked about and worked on this year and got negotiated we're at what we expected. And we don't necessarily get into the economics of that, so it's just we go through it, just like we do every other year. And there are some contracts that we have that there is inflationary pricing mechanisms that are adjusted every year and those contracts are in place, automatically the changes based on inflation just gets pass-through, so it's where we're at, just take every other year nothing's really changed.

[Operator:]

And we can now take our next question from Bryan Spillane of Bank of America. Please go ahead.

[Bryan Spillane:]

So maybe just to pick up first on the Tom questions on around inflation and pricing and I guess more on just focused on inflation. Can you give us sort of an update on what you're seeing now? I think like cooking oils have inflated recently and we know that freight costs are higher. Don't really know or would like to get maybe get some insight too is, in terms of grower inflation just is there inflation and things like, I don't know fertilizer seed potatoes, order. Just trying to get a sense of whether or not the industry or you'll feel maybe a little bit more input inflation as we move into the out-year versus what you've seen over the last - over the last few years?

[Tom Werner:]

Yes. Bryan, I'm not - but that I'm going to address the crop. As we do every year, we don't get into specifics, until we get through the negotiating which that's happening as we're talking here. So down the road, July, October we'll talk about what the overall crop looks like and economics of all that, just like we do every year, so...

[Rob McNutt:]

Yes, Bryan, it is Rob. If you think about it, I mean a lot of that is driven by energy fuel whether it's diesel to run the tractor, whether it's gas going into fertilizer production, things like that and those tend to move together. You've mentioned edible oils specifically, and yeah, there has been a little bit of an upswing in the market, recognize we do hedge and so - and enter into longer-term contracts in that. And so if you put all that together, I think that low-single digit inflation overall is what we're looking at in the near term. And as Tom said, as we go through raw negotiations, we'll see how that comes out.

[Bryan Spillane:]

And then just a second one related to innovation pre-pandemic, you look at last year and there is some nice upside, I guess, from some of the limited time offers and some of the more value added innovation, particularly with QSRs. So as we start to normalize, is there - can you give us just some color on kind of what the innovation pipeline maybe looking like and whether there is maybe a little bit of maybe a pipeline I guess that's maybe backed up a little bit in terms of getting some new products and some innovation into the market, just because it's been so disrupted over the last 10 months or 11 months.

[Tom Werner:]

You can understand is, I'm not going to get into a lot of the specifics of some of the things we're working on. We do have a full pipeline. I will tell you one thing that we are accelerating is our Crispy on Delivery offering and we came out with that about 15 months, 18 months ago and we're applying that technology to some different fry formats. So with the - and it's right in the sweet spot of delivery and drive-through and all those kind of things and we're getting some traction on it. It's a small base, but it's the growth on Crispy on Delivery is accelerating.

[Operator:]

We can now take our next question from Chris Growe of Stifel. Please go ahead.

[Chris Growe:]

Sort of a couple of questions on. The first one just be it in the bit of follow-ons earlier questions. You did note the higher cost approximately potatoes out of storage, that have been storage longer. I'm just trying to get a sense of your potato supply and the adjustments you made to supply to potentially that was later in the year. Do you feel like you're in a good place on the supply and therefore the future cost for processing those potatoes?

[Tom Werner:]

Yes, Chris. Like I said earlier, we're very well balanced with raw needs based on our latest forecast for the remainder of the year. So I feel very comfortable where we're at. And just in terms of the raw cost impact with the demand change last spring-summer, we made a decision to store and around potatoes longer than we ever had. And the implications of that is you just don't get the yield that we're used to based on in stores longer and it's just as a perform in the factories as well as the laundry storage. So we're through all that. Going forward with the current crop in storage, we will process that on a normal timeline as we have in previous years, so it was just a one-off thing. It was a decision based on the change in demand to utilize the old crop longer. So it's, but that's all behind us now.

[Chris Growe:]

Just wanted to clear on that. And then I just have a second question. We've had a number of questions around the - with the large chain contracts and some of the potential pricing elements. So just curious, are there one-time things you're doing or I mean that may weigh on pricing of it that I meant to drive better demand. I know we've talked about limited time offering, quite the opposite of that there could be an item at restaurants used to try to regenerate demand. Are other things are doing that are more pricing promotion driven the short-term and your pricing in those large contracts?

[Tom Werner:]

No. We're not seeing anything, any change that's driving demand. The interesting thing Chris that we - I wish to look at all kinds of different data. The encouraging thing is the importance of fries on menu is at an all time high. Now in theory if you say look if that holds as demand returns that's going to further add to overall French Fry demand going forward. And that's an interesting thing that we're monitoring, right now to understand and whether that holds or not remains we seen, but again, you look for positive in this and that's one thing that is really intriguing to us, because that could be, if it holds to the level that's holding on the importance, menu importance that's going to elevate demand even further than what we believe it's going to come back by the end of the calendar year, which is close of pre-pandemic levels.

[Operator:]

We can now take our next question from William Roger of Bank of America. Please go ahead.

[William Roger:]

I just have two quick ones. Last quarter you laid out what the one-time costs were associated with COVID. I was wondering if you could lay out that again for the second quarter and then what of those will remain post COVID?

[Rob McNutt:]

Yes. This is Rob. In terms of the detail of that cost, we've really concluded that those are just part of our operating cost now. And frankly, if you go back to the first quarter and then when we took a write-off on raw and we were shutting down lines for a long period of time. They were really easy to carve out. We did give some detail on like what the increased sanitation protocols and so forth and PPE and so forth are in the plants and that continues on. The rest of it, as you bring in lines up and down. It's become more difficult to really separate out what's operating versus COVID. And so just embedded into our cost structure on an ongoing basis now and so, it clearly our cost structure should improve as the virus gets less and less. And we have less impact on our pruning, and so forth. It's just gotten to the point where it's part of our normal operations of our business and embedded in our costs. So we're not breaking that out.

[William Roger:]

And then in terms of the gross margin pressures in the quarter that capacity utilization as well as this aged potato crop that had larger storage costs associated with that. I guess, which one of those was larger and will we continue to see the headwind of the elevated storage costs on your inventory or are you through that?

[Rob McNutt:]

Yes. In terms of the storage cost that was just the carryover from old crop. We got through the manufacturer that crop in the first and early part of the second quarter. And so, sitting in inventory and then sold and we're out of that now in the second quarter. So we shouldn't see that as a headwind going forward.

[William Roger:]

Okay. And I guess just one more, if I can sneak it in. The last time you gave us an update on a leverage target, it was 3 times to 4 times, is that still the range?

[Rob McNutt:]

Yes. We haven't changed our leverage targets at all.

[Operator:]

And we can now take our next question from Carla Casella of JPMorgan. Please go ahead.

[Carla Casella:]

Most of my questions have been answered, but I guess given some of the weakness you're seeing. Is there ability to pick up new contracts and new business has that changed. You talked about some of the competition on the lower end and the contracts for the private, but I guess that sounds like it's more your existing. Can you just talk about new businesses and the opportunities there?

[Tom Werner:]

Yes. This is Tom. The team we're always talking to potential new customers, obviously, with the demand change those are more difficult. A lot of the customers that we have embark to is, initially, it was about assured supply, so kind of we got all that settled down as we go through the pandemic and our team, our sales team, are on the ground searching for new opportunities. And that really hasn't changed from a market standpoint.

[Operator:]

This concludes the Q&A session. Mr. Congbalay I would like to hand the call back to you for any additional or closing remarks.

[Dexter Congbalay:]

Thank you all for joining our second quarter call. If you want to step a follow-up session, please pass me an email and we can get that scheduled, but again thanks for joining us and have a good day.

[Operator:]

This concludes today’s call. Thank you for your participation. You may now disconnect.