Lamb Weston Holdings, Inc. (NYSE:LW) Q3 2024 Earnings Call Transcript

Lamb Weston Holdings, Inc. (NYSE:LW) Q3 2024 Earnings Call Transcript April 4, 2024

Lamb Weston Holdings, Inc. misses on earnings expectations. Reported EPS is $1.2 EPS, expectations were $1.4. Lamb Weston Holdings, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day and welcome to the Lamb Weston Third Quarter Earnings Call. Today’s conference is being recorded. At this time, I’d like to turn the call over to Dexter Congbalay. Please go ahead.

Dexter Congbalay: Good morning and thank you for joining us for Lamb Weston’s third quarter 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; Bernadette Madarieta, our Chief Financial Officer. Tom will provide an overview of the ERP transition, the current demand environment and the status of this year’s potato crop. Bernadette will then provide details on our third quarter results as well as our updated outlook for the remainder of fiscal 2024. With that, let me now turn the call over to Tom.

Tom Werner: Thank you, Dexter. Good morning and thank you for joining our call today. This was a challenging quarter as we transition certain central systems and functions in North America from a decades-old legacy enterprise resource planning system to SAP. The transition is the first step towards a multiyear global rollout. Among other areas, the scope of this transition affected receiving and processing customer orders, trade pricing and promotion management, managing inventories and warehousing, scheduling, transportation and shipments, invoicing customers and treasury and cash management. While the transition went well in many areas, it proved more difficult than we expected despite the countless hours we spent planning, testing and preparing for the transition.

Specifically, we experienced significant challenges with inventory visibility at distribution centers which led to shipment delays, canceled orders and ultimately, lower-than-expected volumes in the quarter. In particular, we had more difficulty filling shipments of mixed product loads which are generally higher margin than shipments of single product loads. This pressured margins in the quarter. We partnered closely with our third-party and company-owned distribution centers to minimize the impact of these challenges. This included co-locating Lamb Weston team members at our distribution centers to resolve data errors and processing issues in real time and adjusting systems and processes for balancing inventory between distribution centers and SAP.

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Q&A Session

We also work closely with our customers to limit the impact on their operations and I want to thank them for their patience and commitment as we manage through the transition. Importantly, I also want to thank our Lamb Weston team members who worked around the clock to help restore customer shipments and service back to pre-transition levels. As Bernadette will cover in more detail later, we estimate that the ERP transition reduced net sales by about $135 million and volume growth by approximately 8 percentage points in the third quarter. We also estimate that adjusted EBITDA was negatively impacted by approximately $95 million, with more than half of that due to lower sales and unfulfilled customer orders and the remainder due to incremental costs and expenses directly related to the transition.

As with any transition, our teams are still adapting to the new system. I’m pleased that we have contained the effect of the inventory visibility issues to our fiscal third quarter and restored customer order fulfillment rates to pre-transition levels. We understand that some customers effected by either delayed or canceled shipments may have temporarily secured supply from alternative sources until they gain confidence in our service levels. With healthy warehouse inventory levels and flows throughout the system, we’re actively engaging customers with our direct sales force to earn their trust and their business. Turning now to the demand environment, overall, global French fry demand remains resilient but we believe it’s currently at or below the historical annual growth rate of about 2% to 4%.

According to restaurant industry data providers, restaurant traffic trends in the U.S. have been generally flat to slightly down during the past 6 to 9 months as consumers continue to adjust to the cumulative effect of inflation on menus. QSR traffic during the third quarter was flat versus the prior year after growing modestly during the first half of fiscal 2024. Several QSRs have attributed this to less visits by lower-income consumers as their disposable income has been more affected by the overall inflationary environment. Meanwhile, traffic at full-service restaurants has declined each quarter during fiscal 2024. Outside the U.S., restaurant traffic continued to increase versus the prior year in most of our key markets. But growth has also slowed sequentially from our fiscal second quarter.

Similar to the U.S., we believe traffic in these markets is also affected by consumers adjusting to the cumulative effect of inflation as well as other macro headwinds. Restaurant traffic growth in our larger markets in Europe in the third quarter was mixed. Traffic was up in France, Germany and Italy but at notably slower rates than during the first half of fiscal 2024. Traffic was down in the U.K. and Spain. In Asia, traffic growth in both China and Japan was solid, while in the Middle East, traffic was down. While global restaurant traffic has slowed, the fry attachment rates in North America and in our key international markets have been generally stable. So on the one hand, fries remain as popular as ever with consumers. But on the other hand, consumers are going out to eat less often.

Because of these recent trends, we’re taking a more cautious view of the consumer. In our previous financial outlook, we expect the restaurant traffic and demand would pick up in the fourth quarter. As Bernadette will cover in more detail, we’re now taking a more prudent approach to our expected sales and volume performance in the near term. We currently anticipate volume will decline mid-single digits as opposed to our previous expectation of modest volume growth in the fourth quarter. Despite this near-term caution, we believe the pressure on restaurant traffic and demand is temporary and we remain confident that the global fry category will return to its historical growth rates as consumers continue to adjust to higher menu prices. Turning now to the upcoming potato crop.

In North America, we’ve agreed to a 3% decline in the aggregate and contract prices for the 2024 potato crop and have largely secured the targeted number of acres to be planted across our primary growing regions. Planting is on schedule for the early potato varieties and we expect planning for the main harvest to be completed by the end of April. Although we expect our potato costs in North America to decline somewhat during the second half of fiscal 2025, assuming an average crop, they will likely be offset by a rise in our other input costs. In Europe, prices governed under fixed price contracts are up mid- to high single digits and we’ve contracted for our targeted amount of acres. We’ll provide our typical update on the outlook for potato crops in North America and Europe when we issue our fourth quarter earnings in late July.

So in summary, we believe the impact of the order fulfillment issues has been contained in the third quarter as service levels have been restored to pre-transition levels. Overall, global fry demand remains resilient, although restaurant traffic trends continue to be challenged as consumers adjust to higher menu prices. We have reduced our fiscal 2024 financial targets to reflect these softer traffic trends and the higher-than-expected financial impact of the ERP transition. And finally, we have largely locked in the pricing and acreage needed for this year’s crop in North America and Europe. Let me now turn the call over to Bernadette for a more detailed discussion on our third quarter results and updated outlook.

Bernadette Madarieta: Thanks, Tom and good morning, everyone. As Tom noted, we’re not happy with the magnitude of the impact to the ERP transition on our customers, our business and our P&L. However, I do want to take a moment and say how proud I am of our Lamb Weston team members who did work tirelessly to remedy the issues we experienced and bring our customer order fulfillment rates back to pre-transition levels within the quarter. I also want to thank our sales team members who stayed close to our customers to limit the impact as much as possible on their businesses. Let’s review our third quarter results. Sales increased $205 million or 16% to $1.46 billion. The entire increase was driven by $357 million of incremental sales from the acquisition of the EMEA business.

This is the last quarter that we’ll receive the incremental benefit from the EMEA consolidation since we began to consolidate EMEA sales beginning in the fourth quarter of fiscal 2023. If we exclude the incremental sales from the EMEA acquisition, net sales declined $152 million or 12%. We estimate that the majority of the decline or approximately $135 million was due to unfilled orders attributable to the ERP transition. Price/mix was up 4% as we continued to benefit from the inflation-driven pricing actions taken in fiscal 2023 and pricing actions taken this year in both our North America and international segments. However, unfavorable mix related to the type of orders we were able to fill during the ERP transition partially offset the benefit of the pricing actions.

In addition, lower freight charges to customers were nearly a 5-point headwind which was driven by lower volume shipped and the pass-through of lower freight rates when shipping products to customers. Total sales volumes declined 16%, with about 8 points of the decline associated with unfilled customer orders due to the ERP system transition. The other 8 points of the decline was primarily driven by 2 factors: first, more than half reflected softer-than-expected restaurant traffic trends in North America and key international markets. As Tom mentioned, we believe the traffic trends remain challenging as consumers continue to adapt to higher menu prices. In addition, unusually poor weather in January negatively affected traffic in the U.S. Second, the remainder of the volume decline reflected the carryover impact of exiting lower-margin business during the second half of fiscal 2023.

This is the last quarter in which we will see any meaningful headwind from the 4 notable contracts that we exited last year to strategically manage customer and product mix. Moving on from sales. Adjusted gross profit increased $24 million to $427 million which was driven by the benefit of inflation-driven pricing actions and incremental earnings from the consolidation of the EMEA business. The increase was partially offset by mid-single-digit input cost inflation on a per pound basis and a $20 million charge for the write-off of excess raw potatoes as we considered the softer restaurant traffic trends in North America as well as the higher-than-expected impact on volume from the ERP transition. In addition, we estimate that the ERP transition negatively impacted adjusted gross profit by approximately $88 million.

We estimate that approximately $55 million was due to lower volumes and negative mix. And that the remaining $33 million was due to about $26 million from reduced fixed cost coverage and inefficiencies arising from planned downtime for the ERP transition in our factories as well as additional freight charges as we sought to reduce the impact of shipment delays on our customers and about $7 million for penalties associated with delayed shipments or the inability to fill customer orders. Adjusted SG&A increased $30 million to $164 million, primarily due to incremental SG&A with the consolidation of EMEA as well as higher expenses associated with the ERP system transition, including noncash amortization. The increase includes approximately $7 million of incremental costs to support the system post go-live, including efforts to restore customer order fulfillment rates to pre-transition levels.

A reduction in compensation and benefit accruals tempered the increase in SG&A. All of this led to adjusted EBITDA of $344 million which is down 2% versus the prior year. Lower income in the Lamb Weston base business which includes an estimated $95 million impact from the ERP transition and a $25 million write-off of excess potatoes more than offset incremental earnings from consolidating the EMEA business and the benefit of inflation-driven pricing actions. So on an underlying basis, excluding these items, adjusted EBITDA would have been around $465 million, while sales excluding acquisitions and the impact of the ERP transition would have been down 1% to 2%. 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 declined $123 million or 12% in the quarter.

We estimate that essentially all of that decline was due to unfilled orders and unfavorable mix attributable to the ERP transition. Price/mix was up 5% 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. Mix was unfavorable as higher margin, lower volume customers which typically have more complex mixed product orders were harder to fill until the inventory visibility issues related to the ERP transition were resolved. In addition, lower freight charges to customers partially offset the increase in price/mix by more than 4 percentage points. Volume declined 17% with more than half of the decline reflecting unfilled customer orders resulting from the ERP transition.

The remainder of the decline primarily reflects soft restaurant traffic and retail trends as well as the carryover impact of exiting lower-margin business during the second half of fiscal 2023. North America segment adjusted EBITDA declined 14% to $286 million. The decline was largely driven by an estimated $83 million impact from the ERP transition and $23 million charge for the write-off of excess potatoes, of which about $5 million of the excess potato write-off was incurred at our North American joint venture. The impact of lower volumes and higher cost per pound also contributed to the decline. These factors more than offset the benefit of inflation-driven pricing actions. Sales in our International segment which includes sales to customers in all channels outside of North America, grew nearly $330 million, of which $357 million were incremental sales from the EMEA acquisition.

Excluding the EMEA acquisition, net sales declined $29 million or 16%. We estimate approximately $12 million of that decline relates to unfilled orders attributable to the ERP transition. Price/mix was up 1%, driven primarily by the carryover benefit of pricing actions taken last year as well as pricing actions taken this year. Lower freight charges to customers partially offset the increase in price/mix by about 5 percentage points. Sales volume declined 17% with more than half of the decline, reflecting the carryover impact of exiting lower-margin business during the second half of fiscal 2023. The remainder of the volume decline reflects unfilled customer orders served by North American exports as a result of the ERP transition. International segment’s adjusted EBITDA increased 88% to $102 billion.

Incremental earnings from the consolidation of EMEA’s financial results drove the increase. Excluding the EMEA acquisition, higher cost per pound, an estimated $5 million impact from the ERP transition, lower volumes and a $2 million allocated charge for the write-off of excess raw potatoes more than offset favorable price/mix. Let’s move to our liquidity position and cash flow. Our balance sheet remains strong. We ended the quarter with a net debt leverage ratio of 2.6x adjusted EBITDA, up from 2.4x at the end of the fiscal second quarter. Our net debt increased about $270 million to $3.8 billion as we drew on our revolver to largely finance increased working capital needs during the ERP system transition as well as increased capital expenditures.

We continue to have ample liquidity, including more than $900 million available under our revolving credit facilities. In the first 9 months of the year, we generated more than $480 million of cash from operations, up about $145 million versus the prior year period, primarily due to higher earnings. We spent nearly $830 million in capital expenditures which is up about $330 million from the prior year period. The increase primarily reflects construction and equipment costs for our new China factory that started up in November as well as costs related to our capacity expansion projects in Idaho, Netherlands and Argentina. And finally, we’ve returned more than $270 million of cash to our shareholders, comprised of $122 million in dividends and $150 million in share repurchases.

Turning to our updated fiscal 2024 outlook. We updated our full year sales and earnings targets to reflect the impact of the ERP system transition as well as near-term demand trends. Specifically, we reduced our annual net sales target to $6.54 billion to $6.6 billion from our previous target range of $6.8 billion to $7 billion. The updated range includes $1.1 billion of incremental sales attributable to the EMEA acquisition during the first 3 quarters of the year. Our updated sales target implies sales of $1.69 billion to $1.75 billion in our fiscal fourth quarter which is flat to up 3% compared with the same period a year ago. We expect price/mix will drive our sales growth in the fourth quarter, reflecting the continued carryover benefit of inflation-driven pricing actions taken in fiscal 2023 and actions we’ve taken in fiscal 2024.