Edited minutes of the conference call or presentation on the LW.N result from January 3 to January 20, 3:00 p.m. (GMT)

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EAGLE January 4, 2020 (Thomson StreetEvents) – Edited transcript of the conference call or presentation on the outcome of Lamb Weston Holdings Inc Friday, January 3, 2020 at 3:00 p.m. GMT

* Dexter P. Congbalay

Lamb Weston Holdings, Inc. – Vice President of IR

* Robert M. McNutt

Lamb Weston Holdings, Inc. – Senior Vice President and Chief Financial Officer

* Thomas P. Werner

Lamb Weston Holdings, Inc. – President, CEO and Director

* Adam L. Samuelson

Hello and welcome to the Lamb Weston Earnings Call for the second quarter of 2020. Today's conference is being recorded.

At this point I would like to hand the conference over to Lamb Weston's VP Investor Relations, Dexter Congbalay. Please continue.

Dexter P. Congbalay, Lamb Weston Holdings, Inc. – Vice President of IR [2]

Good morning and thank you for coming to Lamb Weston's earnings call for the second quarter of 2020. This morning we released our press release on the result, which is available on our website lambweston.com.

Please note that during our remarks we will make some forward-looking statements about the company's performance. These statements are based on how we see things today. Actual results may differ materially due to risks and uncertainties. For more details on our forward-looking statements, please refer to the warnings and risk factors contained in our filings with the SEC. Some of today's statements contain non-GAAP financial measures. These non-GAAP financial measures are not a substitute for our GAAP results and should be read together with them. The reconciliations from GAAP to non-GAAP can be found in our earnings release.

With me today are Tom Werner, our President and Chief Executive Officer; and Rob McNutt, our CFO. Tom will provide an overview of our performance, some recent capital allocation measures and an update to the current operating environment. Rob will then provide details of our second quarter results and our updated outlook for fiscal 2020.

Now let me transfer the call to Tom.

Thomas P. Werner, Lamb Weston Holdings, Inc. – President, CEO and Director [3]

Thanks, Dexter. Happy New Year and thank you for joining our call today. We delivered another strong quarter as we continue to do well. In particular, sales increased by 12%, which is due to strong volume growth and a favorable price-performance ratio in each of our core business areas.

EBITDA, including unconsolidated joint ventures, increased 17%, while adjusted diluted earnings per share increased 19%. In the first half of the year, we generated operating cash flow of $ 345 million. Due to our good results since the beginning of the year and the good operational dynamics, we have raised our outlook for the 2020 financial year for both sales and EBITDA. As Dexter mentioned, I would like to keep you up to date on some capital allocation measures that we have recently taken and our thoughts on potato harvesting in the current operating environment.

For capital allocation. In October we acquired a 50 percent stake in a new joint venture in Argentina. This GU will give us better access to a strategic and growing market in which we were underrepresented. Before this investment, our market share in South America was less than 2%. While the joint venture is now modest in size, it provides a good basis for expansion to serve the wider South American market with an inexpensive, high quality product. This should enable us to achieve faster share growth in the long term.

We continue to invest capital in this business to support customer growth. Since 2014 we have added 3 new fries lines. And despite these additions, our current capacity utilization is above our targeted operating rates, as demand has recently grown faster than the historical average. We're not ready today to announce capacity expansion projects, but we're aggressively exploring ways to expand production capacity inside and outside North America to support our customers' growth. We look forward to sharing our expansion plans with you soon. In the meantime, we are actively working to expand existing capacities by eliminating bottlenecks and increasing productivity.

Finally, in addition to reinvesting in business, we continue to work to return capital to shareholders. Last month, we announced a 15% increase in our quarterly dividend to $ 0.23 a share, or $ 0.92 a year. This puts our dividend payout ratio at around 27% based on the past 12 months, which is within our target payout range of 25% to 35%. We will continue to add dividends to our dividends. We repurchased approximately $ 8.5 million of shares in the second quarter, which is largely in line with our goal of at least compensating for the dilution of the share compensation. We estimate that we will have to repurchase approximately $ 40 million in shares each year.

Now switch to the potato harvest. Recent press reports have led to market fears about the lack of raw potatoes and french fries. As we discussed last time we asked for a profit, harvesting in our Columbia Basin and Idaho growing areas will produce the vast majority of our raw potatoes. Where we have the most production facilities, the historical averages in terms of yield and yield match quality. We therefore assume that we can operate our systems there at normal utilization levels.

In Alberta, Canada, where we have 1 plant, crop yields and quality are below average due to adverse weather conditions during the growing and harvesting periods. However, we were able to secure enough potatoes to operate this facility on normal terms. However, potato availability in Alberta is limited overall.

In Minnesota, where we have a single facility through our Lamb Weston RDO joint venture, crop yields and quality are below average, also due to poor weather conditions during the growing season and harvest times. As a result, potato availability in the upper Midwest will also be limited. However, our partner in this plant is the main supplier of raw potatoes and expects the plant to work properly.

We also know that crops and other major growing areas such as Manitoba and Prince Edward Island are below average due to the weather. This limits the availability of potatoes in North America. It is important to note that we currently do not source raw potatoes from these regions. Let me be clear, given our concentration of processing plants in the Columbia Basin in Idaho, our strong relationships with farmers in Alberta and the Midwest, and above all our decision to source open potatoes a few months ago, we are confident that this will be the case Case is we have raw potatoes to meet our volume growth targets for the rest of our fiscal year. However, the supply of potatoes in North America is scarce and this could put pressure on our ability to take advantage of gradual growth opportunities at home and abroad this year. Accordingly, we will continue to explore ways to improve price and mix in each of our businesses.

Let us now turn to Europe. The potato supply there is also likely to be a challenge for the late harvest due to the quality and weather conditions. Compared to the historically poor harvest last year, the potato harvests in the Netherlands and Belgium are better this year, but still below average. The harvests in Germany, Poland and Great Britain are more demanding. As a result, raw potato prices in Europe remain higher than the historical average, but are below the prices we saw last year. We therefore assume that Lamb Weston / Meijer's performance will continue to improve compared to the previous year, as the cost pressure will ease in the second half of our fiscal year as a result of the new harvest.

Regarding the operating environment, we expect North America's capacity utilization to remain high in the second quarter, and this is expected to continue to be the case for the rest of our fiscal year, provided raw potatoes are available. We believe that the global growth in demand for frozen potato products is generally favorable and will remain so until the 2020 financial year. As in the beginning of the year, demand in the United States was supported in the second quarter by a positive development in restaurant traffic and fast service traffic. The growth was again strong, led by growth in chicken stores.

Demand in our major international markets and in Europe continued to grow in line with the latest trends. Together, these factors contributed to our strong volume growth in the quarter, particularly in our global segment. In summary, we achieved a strong result for the second quarter and the first half of the year. We expect the overall environment for the annual balance sheet to remain generally favorable, based on solid growth in demand. We are well positioned with raw potatoes to achieve our volume targets. Finally, the successful implementation of our strategy results in strong cash flows that allow us to continue investing in the business to support growth and increase return on investment for shareholders.

Let me now call Rob to provide details of our second quarter results and our updated outlook.

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Robert M. McNutt, Senior Vice President and CFO of Lamb Weston Holdings, Inc. [4]

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Thanks, Tom. Good morning everyone. As Tom noted, we had another strong performance in the quarter and first half of the year. In particular, quarterly sales increased 12% to $ 1,019 million, with volume growth and value for money in each of our core business segments. Volume grew 10%, led by growth in our Global and Foodservice segments. Our two acquisitions in Australia, Marvel Packers and Ready Meals, saw volume growth of approximately 1.5 points. In addition, we had some additional shipping days than in the second quarter of the 2019 fiscal year due to Thanksgiving. These additional days contribute to further strong volume growth. As a result, this will impact third quarter results year over year. Price / mix increased by 2% due to price measures and cheap mix.

Our strong sales growth resulted in a $ 36 million or 14% increase in gross profit. Value for money, volume growth and lower transportation costs contributed to the increase and more than offset the impact of higher manufacturing costs due to inefficiencies and higher depreciation costs associated with our new Hermiston production line.

In addition, the increase in gross profit included a gain of $ 4 million from unrealized market value adjustments related to security contracts. This contrasts with a loss of USD 2 million in the same period last year. Our gross margin percentage increased by 65 basis points to 28%. Without taking market value adjustments into account, it rose by around 5 points.

While we made great strides in improving our planned operating performance compared to the first quarter, we continued to experience higher-than-normal periods of unscheduled downtime in the second quarter, which affected our level of production. This affected the absorption of fixed costs, increased overall maintenance costs, and reduced recovery rates. In addition, part of the cost we realized in the second quarter was a carryover as we worked through the finished goods inventory in the first quarter. Since our factories are now operating at a more normal level, we expect our third quarter results for the third quarter of the fiscal year to have little impact from these production efficiencies.

SG&A expenses were $ 92 million, an increase of approximately $ 17 million. Approximately $ 6 million of this increase was related to higher incentive allowance provisions, primarily based on our performance. Approximately $ 4 million of the change reflects an insurance policy that we had last year. However, this was partially offset by a $ 2 million decrease in exchange rate losses. Investments in sales, marketing, and operations accounted for approximately $ 7 million of the increase. Ultimately, more than $ 2 million was spent on developing and implementing our new enterprise resource planning system. As mentioned earlier, this year we are expected to spend approximately $ 10 to $ 20 million in one-off costs for implementing a new ERP system. So far, we've spent around $ 4 million, so we expect spending to increase in the second half of the year.

Operating income increased $ 20 million, or 11%, to $ 194 million. This reflects solid sales and gross profit growth. Equity income from our non-consolidated joint ventures, which included Lamb Weston / Meijer in Europe, Lamb Weston RDO in Minnesota and our new joint venture in Argentina, was $ 15 million in the quarter. Excluding fair value adjustments, equity earnings increased $ 6 million, largely due to lower raw potato prices in Europe.

Overall, EBITDA including joint ventures increased $ 38 million, or 17%, to $ 261 million. The operating profits of our base business as well as the contributions from the BSW consolidation and the Australian acquisitions contributed to an EBITDA growth of around USD 32 million. Our unconsolidated joint ventures contributed approximately $ 6 million.

Shift the profit and loss account down. Interest expense was approximately $ 25 million, approximately $ 1 million lower than the previous year. Our effective tax rate was more than 23% or around 2 points higher than last year due to discrete items.

Let us turn to earnings per share. Adjusted diluted EPS increased $ 0.15 or 19% to $ 0.95. Operating gains in our base business and a higher equity result contributed to the increase. The BSW consolidation also gave us an advantage of approximately $ 0.04.

Now let's review the results for each of our businesses. Global segment sales, which include the top 100 changes in the United States and all sales outside of North America, increased 15%. The volume grew by 14%. The increase was driven by higher sales, including the sale of limited-time offerings to strategic customers in the United States and key international markets. It also includes a 3-point benefit from the acquisitions in Australia and a 1-point benefit from the additional shipping days related to the Thanksgiving date.

The price-performance ratio increased by 1%, mainly due to price adjustments in connection with multi-year contracts. Global product contribution, which is gross profit less advertising and promotion costs, increased $ 17 million or 15%. Volume growth, value for money and lower transportation costs contributed to the increase, which was partially offset by higher manufacturing costs and higher depreciation costs related to the Hermiston line.

Sales of our food service segment, which serves North American food service distributors and restaurant chains outside of the 100 largest North American restaurant customers, rose by 9%. Volume increased 5%, driven by growth in Lamb Weston brand and products. Around half of the increase in volumes was attributable to the additional shipping days in the quarter. Even after adjusting for the Thanksgiving postponement, we achieved our fourth consecutive quarter of volume growth as our direct sales continued to strengthen customer relationships. The price-performance ratio increased by 4%, which is mainly due to the price measures taken in October. Foodservice's product contribution increased $ 14 million, or 14%. Favorable price-performance ratio, volume growth and lower transport costs more than offset higher manufacturing costs and depreciation costs.

Sales in our retail segment increased 7%, reflecting volume growth of 4 points due to increased sales of branded and private label products. Around 2 points of the volume growth can be attributed to the additional shipping days in the quarter. The price / mix rose 2-3%, sorry, mainly due to cheaper mix and price promotions. Retail product contribution increased $ 3 million, or 10%. Favorable price / mix and volume growth contributed to the increase and was partially offset by higher manufacturing costs, depreciation and A&P expenses.

Moving to our balance sheet and cash flow. Our total debt was approximately $ 2.2 billion at the end of the quarter. Our ratio of net debt to EBITDA is 2.6x. In terms of cash flow, we generated cash from continuing operations of nearly $ 345 million in the first half of the year. That is 9% more than in the previous year, which is due to our profit growth. We spent approximately $ 135 million on acquisitions, including an initial payment of $ 17 million for half of the new joint venture in Argentina. We also invested nearly $ 110 million in investments and IT projects together. In addition, we repurchased more than $ 13 million in stock and distributed dividends of $ 59 million to our shareholders.

Let us turn to our updated outlook for the 2020 financial year. As Tom noted, our strong performance in the first half of the year raised our sales and earnings prospects for the full year. Reminder: Our goals include the 53rd week contribution, which will benefit the fourth quarter. Overall, we remain cautious about updating our outlook for the year.

For the year as a whole, we are now aiming for sales growth in the upper range of our original medium to high single-digit rate range. We continue to believe that sales will primarily depend on volume and price / mix increases will be achieved to offset inflation of input costs. As you know, we achieved 10% sales growth in the first half of the year, including a 2% higher price mix and robust 8% volume growth. We expect our volume growth to weaken in the second half of the year for several reasons. Volume growth in our Global segment was faster than expected in the first half of the year, as domestic QSR traffic was above historical trends and international demand was also above our original expectations. We expect global demand to remain generally cheap in the second half of the year. However, we assume that these trends will gradually normalize towards historical growth rates.

In our global segment, too, we will generate strong sales with limited-time product offerings in the third quarter. In the third quarter, too, we noticed a headwind of around 1 percentage point due to the lower number of shipping days compared to the same quarter in the previous year due to the Thanksgiving time. This will affect each of our core businesses, with the strongest impact in our food service segment.

Finally, in our retail segment, we will see the effect of losing some low-margin contracts in our private label business.

In short, we expect to see solid revenue growth in the second half of the year, primarily driven by volume growth with a slightly higher price-performance ratio. In terms of earnings, we raised our annual adjusted EBITDA target, including unconsolidated joint ventures, to $ 965 to $ 985 million. This ranges from $ 950 to $ 970 million.

For the second half of the year, we expect gross profit to grow largely in line with sales growth, with volume growth and a favorable price / mix ratio to offset input cost inflation and higher depreciation expenses. As a result, we expect the gross margin portion to remain essentially unchanged in the second half of the year. However, the gross margin in the third quarter could come under pressure due to the difficult comparison to the previous year. Gross margin in the third quarter of fiscal 2019 included a $ 4 million gain on unrealized gains from hedge contracts, a mix gain due to the strong sales of higher margin, time-limited products in our global segment, and a cost benefit from supply chain efficiency, particularly in the edible Oils and transportation area.

Regarding SG&A costs. For the year, we continue to expect that our basic SG&A expenses, advertising and promotion costs, as well as one-time ERP investments, will be within our target range of 8% to 8.5% of sales. A&P costs in the second half of the year are expected to be slightly higher than the $ 11 million previously spent. As previously mentioned, we anticipate that total ERP system implementation spending will increase over the one-time expense of $ 4 million in the first half of the year. For the full year, we continue to target one-time total project related costs of between $ 10 and $ 20 million.

We continue to expect equity to gradually improve in the second half of the year, although the potato harvest in Europe is again somewhat in question.

In summary, we will see solid EBITDA growth in the second half of the year, including joint ventures driven by revenue and gross profit growth and an improved equity result. This growth is dampened by higher SG&A costs as we increase spending on our ERP implementation. In addition, please note that BSW consolidation generated a profit of around $ 10 million in the first half of the 2019-2020 fiscal year, please excuse me. Since we closed this transaction in mid-2019, we will no longer have this benefit in the second half of this fiscal year.

After all, most of our other financial goals remain the same. We continue to target total interest expense of approximately $ 110 million, total depreciation expense of approximately $ 175 million and total investments, including some investments in our new ERP system of approximately $ 300 million. We have updated our effective tax rate target to around 24%. This is at the upper end of our previous estimate of 23% to 24%.

Now back to Tom for some final comments.

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Thomas P. Werner, Lamb Weston Holdings, Inc. – President, CEO and Director [5]

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Thanks, Rob. Let me summarize that we are satisfied with our strong performance in the first half of the year as we continue to do well in an overall favorable environment. We have raised our full year sales and EBITDA targets and remain cautious with our updated outlook. With our raw potato supply, we are well positioned to meet our volume targets and support customer growth. We continue to focus on reinvesting in our business to achieve long-term growth, return capital to shareholders and create value for all of our stakeholders. I would like to thank you for your interest in Lamb Weston and look forward to answering your questions.

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questions and answers

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operator [1]

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We will answer our first question from Andrew Lazar with Barclays.

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Andrew Lazar, Barclays Bank PLC, Research Department – MD & Senior Research Analyst [2]

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Two questions if I could, Tom. As you mentioned earlier, I estimate that Lamb Weston achieved sales of approximately 10% in the first half of the year, even without the benefits of holiday timing. Reaching the upper mid-single-digit range for the full year suggests sales growth in the back half of about 2% in the low single-digit range. And I realized that you and Rob were going through some of the factors that saw first-half revenue growth exceed your expectations. But I think – what would drive this kind of fairly significant slowdown, especially if the positive restaurant trends are likely to continue? And then I have a follow-up exam.

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Robert M. McNutt, Senior Vice President and CFO of Lamb Weston Holdings, Inc. [3]

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Andrew, it's Rob. Again, it's consistent. We believe that we are careful with our prospects. As you say, middle – the upper end of the middle single-digit number, we may stretch it a little further than you and you just said 6. And I think you notice that somewhere in the 7% range is where we think it ends. But also here we assume that we will return to normal growth rates in the second half of the year, in which we accelerated the growth rates, especially in international business. Global segment.

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Thomas P. Werner, Lamb Weston Holdings, Inc. – President, CEO and Director [4]

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And Andrew, that's Tom. On the other hand, I think the traffic development in the restaurant was favorable because we thought we were very reasonable, a few things that I have alluded to in previous calls. The first quarter grew 2%, traffic increased 1% last quarter, which is important, and it is really difficult to predict in this area. So we're absolutely conservative. But we have – this is a trend that we will observe in the future. And if the trends continue as they are, we could of course see some of them.

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Andrew Lazar, Barclays Bank PLC, Research Department – MD & Senior Research Analyst [5]

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I have it. No, that's a helpful perspective. And then you mentioned that the 1% price / mix you saw in the Global segment was primarily determined by multi-year contracts. And I'm curious to see whether with a certain pricing structure, such as has been introduced recently, it can be expected at Global that the price / mix there will accelerate somewhat one after the other into the rear half of the financial year? Or did I do it wrong?

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Thomas P. Werner, Lamb Weston Holdings, Inc. – Präsident, CEO und Direktor [6]

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Yes. Also – nur um es zurückzusetzen, Andrew, unser globales Vertragswesen endete dort, wo wir es geplant hatten. Und es gab Vor- und Nachteile, netto-netto, als wir dieses Geschäftsjahr auf der Grundlage unserer Einschätzung planten, dass die Umwelt es uns ermöglichen würde, Preise zu erzielen, landeten wir sozusagen dort, wo wir dachten. Was Sie also in Bezug auf die Preise, die wir während der Vertragsverhandlungen erhalten haben, in Global sehen, wird es für den Rest des Jahres ziemlich stabil sein. Und ich würde sagen, denken Sie daran, wenn wir ein internationales Volumenwachstum haben, wie wir es getan haben, war es wieder vor dem, was wir projiziert haben. Die Preise auf diesen internationalen Märkten unterscheiden sich von unseren Preisen auf unserem nordamerikanischen Markt. Damit erhalten Sie einen verwässernden Preisfaktor.

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Operator [7]

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Wir werden unsere nächste Frage beantworten, und das ist von Adam Samuelson mit Goldman Sachs.

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Adam L. Samuelson, Goldman Sachs Group, Research Division – Aktienanalyst [8]

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Ich glaube, ich hatte gehofft, dass Sie es könnten [go] auf die Diskussion über das globale Geschäft ein wenig. Und wenn Sie ein wenig die Wachstumsraten Ihres Exportgeschäfts außerhalb Nordamerikas im Verhältnis zum Inlandsgeschäft gegenüberstellen könnten, könnte das Volumenwachstum des Segments erneut deutlich über dem Verkehrswachstum von 1% für QSR liegen, das Sie gerade gesehen haben zitiert. Ich versuche nur, ein Gefühl dafür zu bekommen, welche Regionen vielleicht einen Beitrag leisten, wenn Sie glauben, dass die USA von anderen Exportregionen profitieren. Nur jede zusätzliche Farbe wäre hilfreich.

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Thomas P. Werner, Lamb Weston Holdings, Inc. – Präsident, CEO und Direktor [9]

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Yes. Ich werde nicht auf bestimmte Marktwachstumsraten eingehen. Wir haben normalerweise nicht darüber gesprochen. Aber was ich Ihnen sagen und wiederholen möchte, sind die internationalen Märkte, zumindest in diesem letzten Quartal, die über den historischen Durchschnittswerten gewachsen sind, und das gilt auch für Nordamerika. Wenn wir also wieder über die Zukunft nachdenken, gehen wir vorsichtig mit unseren Perspektiven um und verzeichnen in der Geschäftseinheit Global ein starkes Wachstum in der ersten Hälfte des internationalen und nordamerikanischen Marktes. Und wir werden sehen, wie sich alles in den nächsten Quartalen entwickelt, aber ehrlich gesagt war es nur eine starke Nachfrage.

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Robert M. McNutt, Senior Vice President und CFO von Lamb Weston Holdings, Inc. [10]

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Yes. Adam, das ist Rob. Die andere Sache, die ich sagen würde, bezog sich darauf. Tom erwähnte es in seinen Kommentaren, dass der Verkehr zwar 1% betragen mag, unsere Gewichtung der Kunden in Nordamerika jedoch etwas stärker sein mag und dass wir möglicherweise stärker als der Markt gewichtet sind, und genau dort Sie hatten ein übergroßes Wachstum.

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Adam L. Samuelson, Goldman Sachs Group, Research Division – Aktienanalyst [11]

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Okay. Diese Farbe ist sehr hilfreich. Und genau so, wie wir über die Auswirkungen einiger Rohkartoffelknappheiten in verschiedenen Teilen Nordamerikas nachdenken, hilft es mir, nicht nur das Geschäftsjahr 2020 an sich, sondern den gesamten Kalender 2020 zu überdenken Wie wird der Markt das aufnehmen oder damit umgehen? Und wenn sich Preis- und Mischungsmöglichkeiten ergeben würden, würde das im Mai-Quartal passieren? Ist es mehr – glaubst du, dass es im August mehr Druck gibt, bevor du zur nächsten Ernte kommst? Können Sie den Kalender ein wenig darlegen, wie sich einige dieser Probleme mit rohen Kartoffeln auf den Markt auswirken könnten und wie sich einige Gelegenheiten bieten könnten?

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Robert M. McNutt, Senior Vice President und CFO von Lamb Weston Holdings, Inc. [12]

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Yes. Ich denke es ist – meine Erfahrung mit Situationen wie dieser ist, dass Sie haben – Sie müssen geduldig sein. Und wir werden sehen, wie sich das alles im Frühling auswirkt, ganz offen. Und die Industrie kann verschiedene Maßnahmen ergreifen, um die Kartoffelversorgung zu verbessern. Egal, ob es sich um eine frühe Ernte handelt, Sie planen mehr Hektar. Es gibt verschiedene Dinge. Also ist es wirklich ein bisschen früh, Adam, darüber zu spekulieren, was passieren wird. We have an idea, but we have to — the most important thing for us is we are well positioned with the raw potatoes that we've secured, we got ahead of it. So we're going to take care of all our customers' needs. We will opportunistically evaluate opportunities that may come our way. But our focus is to execute against our customers and the plans that they have and drive their growth. That's it. And if there's things that come our way, we'll evaluate it as they happen.

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Operator [13]

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We will take next question and that is from Tom Palmer with JPMorgan.

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Thomas Hinsdale Palmer, JP Morgan Chase & Co, Research Division – Analyst [14]

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You gave a lot of helpful color on the potato crop in North America. I hope you could maybe provide a bit of quantification on your annual outlook for potato and non-potato costs? And also, how you see COGS inflation in the second half of the year relative to what seemed to be low single-digit inflation in the first half?

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Robert M. McNutt, Lamb Weston Holdings, Inc. – Senior VP & CFO [15]

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Yes. Tom, this is Rob. In terms of our inflation, again, as we've talked about before, we contract a — the vast majority in the high-90s of our needs for the year. And as Tom mentioned in his remarks, before things started to run up, we — our guys did a great job of getting ahead of it and contracting for the remainder of the potatoes that we needed a small amount — additional that we needed. And so we're still targeting our COGS inflation to be really in line with what it's been in the first half of the year, and so those kind of low single-digit inflation.

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Thomas Hinsdale Palmer, JP Morgan Chase & Co, Research Division – Analyst [16]

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Big. And then I just wanted to clarify something. You've mentioned a few times opportunities that may come your way on the price/mix side. I just wanted to clarify, this is more related to potentially seeing the migration of customers who might not be able to get the volumes that they might typically procure from others? Or are you also considering maybe a regularly timed list price increase?

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Thomas P. Werner, Lamb Weston Holdings, Inc. – President, CEO & Director [17]

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It's more of the first, I would say. But again, like I said earlier, we'll see how that all plays out. I've seen instances when we've had situations like this with raw in other areas of the world, where everybody just managed through it. So we just, again, have to be patient, execute against what our plans are, take care of our customer needs. And if there's customers that come to us that are — want us to provide product then we'll evaluate that.

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Operator [18]

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We will take our next question from Chris Growe with Stifel.

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Christopher Robert Growe, Stifel, Nicolaus & Company, Incorporated, Research Division – MD & Analyst [19]

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I just had a question for you first on a comment you made about capacity utilization, and we're seeing this really strong volume growth. And I just want to understand how limiting this could be to your volume growth going forward, perhaps around LTOs? And then given the time it takes to build capacity, I know you're always thinking about that, but I'm just trying to understand where we are in that thought process? And could we see more capacity or the need for more capacity coming more quickly?

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Thomas P. Werner, Lamb Weston Holdings, Inc. – President, CEO & Director [20]

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Yes. Chris, it's Tom. A couple of things. As I said in my prepared remarks, we're aggressively evaluating capacity addition in our current footprint inside and outside North America. That's number one. And the second thing is our supply chain team has a full-court press on operating efficiency and projects on unlocking capacity in our footprint today. So in terms of where we're at, I feel good about the near future, if you will, on our ability to unlock capacity and drive efficiencies to support volume growth on a normalized level. But again, to your point, what you're pushing at is, we're evaluating additional capacity in our network, and that's just a function of the overall category growth that we continue to see.

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Christopher Robert Growe, Stifel, Nicolaus & Company, Incorporated, Research Division – MD & Analyst [21]

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It sounds like a good place to be in. I got that. And then just 1 quick follow-on. And perhaps, this relates to the strong volume growth in the quarter. But you had a much stronger gross margin performance this quarter, and pricing was just a touch below what I thought, but it sounds like that was more than compensated for the cost inflation. So was it just the volume growth and the efficiencies in the quarter that allowed for the stronger gross margin performance?

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Robert M. McNutt, Lamb Weston Holdings, Inc. – Senior VP & CFO [22]

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Yes. Chris, this is Rob. We did have good gross margin performance and spot on. We had good pricing, especially in the Foodservice, as you see, but really good cost control, I would say. And recall, in Q1, we had some headwinds that we talked about in terms of operating inefficiencies and the plants not running particularly well. And so a lot of that's cleaned up and we operated better. We're still not all the way to bright through Q2, but a lot closer, and so we cleaned up a lot of that. And so input cost inflation was managed well and then the operating level of the plants was a lot better.

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Operator [23]

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We will take our next question from Rebecca Scheuneman with Morningstar.

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Rebecca Scheuneman, Morningstar Inc., Research Division – Equity Analyst [24]

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So I just — I'm really impressed with this volume growth in your Global segment. And you did mention that part of that was driven by some benefits to the chicken segment. I'm wondering also if given your relative favorable sourcing of raw potatoes in your regions, how the quality, your experience is better than some of your competitors out East? Is it also some share gains possibly that is driving some of the strength?

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Thomas P. Werner, Lamb Weston Holdings, Inc. – President, CEO & Director [25]

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Yes. This is Tom. In terms of quality, your — for kind of your first question, the industry is kind of on an even playing field. There's areas that are better. There's areas that are worse in terms of raw potatoes. So I wouldn't attribute the volume growth to any raw quality advantages. It's all about getting ourselves positioned over the crop year to ensure that we have the raw potatoes available for our customers' growth. And I talked about this on this call at nauseam, but we're in a great position. So it's not about the raw potatoes, it's about traffic, and it's about the markets in our global markets across the globe. The demand was just better than we expected. And so it's really about what I talked about previously, we've had — Q1, we had good traffic; Q2, we've seen an increase in traffic year-over-year. So if that continues, then we're in a great position to support that.

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Rebecca Scheuneman, Morningstar Inc., Research Division – Equity Analyst [26]

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Okay. Big. And the second question I have is just — is it safe to assume that the negative hit in Q3 from the timing of Thanksgiving is also going to be about 1%?

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Robert M. McNutt, Lamb Weston Holdings, Inc. – Senior VP & CFO [27]

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Yes. I went through those details earlier. You can follow up with Dexter again to reiterate that.

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Operator [28]

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We'll take our next question from Bryan Hunt with Wells Fargo Securities.

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Bryan Cecil Hunt, Wells Fargo Securities, LLC, Research Division – MD & Senior Analyst [29]

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My first question, and I'm sorry if I'm beating on the subject. But if you look at your global sales, they accelerated sequentially and even backing out the adjustment for the calendar as well as the acquisitions you saw acceleration, and that's with a declining trend in restaurant traffic. So based on your previous comments, you saw QSR traffic up 2% and then up 1%, but yet your sequential growth accelerated. So I was wondering if you could dive into that, where there any contract wins? Do you see some incremental initial benefits of shortages in parts of the world where you all took share? Again, it's a very important topic, and I was just wondering if you could dig into it a little bit more for us.

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Robert M. McNutt, Lamb Weston Holdings, Inc. – Senior VP & CFO [30]

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Yes. Bryan, this is Rob. Again, as I talked about in prepared remarks, that we did have good growth in the international side of our Global business and then good QSR growth here domestically. And then as we talked about, our waiting in QSRs, maybe some customers that had a little stronger growth rates. And so I think that contributes a lot of it. And then as we look forward, again, went through the comps and where we had some good LTO performance last year in the third quarter that we may not see this year in the third quarter.

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Bryan Cecil Hunt, Wells Fargo Securities, LLC, Research Division – MD & Senior Analyst [31]

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So I guess, basically, there's no reason for us to believe that there's a level of permanence that you all will grow above the industry overall?

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Robert M. McNutt, Lamb Weston Holdings, Inc. – Senior VP & CFO [32]

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Nothing that we've reflected to.

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Bryan Cecil Hunt, Wells Fargo Securities, LLC, Research Division – MD & Senior Analyst [33]

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Okay. My next question is you obviously mentioned historically, looking at capital allocation, say your target leverage is 3.5 to 4x. You're running at 2.6 based on your comments. And you'll generate significant free cash flow based on our projections over and above your incremental dividend and your maybe $40 million worth of share repurchase. So basically, you all have to do something meaningful to get back within that 3.5 to 4x bandwidth. So do you all feel like you adjust your financial targets down to something lower in terms of leverage? And if that's the case, do you feel like that makes you an investment-grade company instead of a high-yield company?

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Thomas P. Werner, Lamb Weston Holdings, Inc. – President, CEO & Director [34]

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Yes. So this is Tom. Consistent with what we've talked about in the past, since we've been public, we have 3 priorities: first one is we're going to continue to invest in this business, and that means adding capacity and that costs $350 million to $400 million when we decide to pull that trigger; second, we are going to actively pursue M&A; and third, we're going to return capital to shareholders. And so I'm comfortable with where our leverage is. I think our investment rating right now gives us the opportunity to pursue potential M&A as we have in the past and our brands have been small bolt-on acquisitions. But I want to make sure I've got plenty of balance sheet capacity to do a potential big deal if that comes around. So I feel good about where our leverage is. And it gives us — with our cash flow, we're returning shareholders — we're returning capital to shareholders with dividend increase that we just recently announced and our share buyback program, and I want to have some balance sheet available to pursue opportunities in the marketplace.

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Bryan Cecil Hunt, Wells Fargo Securities, LLC, Research Division – MD & Senior Analyst [35]

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I guess the only thing, based on our math, that would get you back to that 3.5 to 4 turns of leverage would be a sizable acquisition. Is there anything on the horizon? Or is there anything out there available for sale that is sizable in your opinion at this moment?

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Thomas P. Werner, Lamb Weston Holdings, Inc. – President, CEO & Director [36]

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Well, I'm not going to get into specifics. What I will tell you is we're as active as we can be in the market.

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Operator [37]

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We will take our next question from Carla Casella with JPMorgan.

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Carla Casella, JP Morgan Chase & Co, Research Division – MD & Senior Analyst [38]

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On the CapEx side, I had a question, the $300 million CapEx. Can you just remind us how much of your CapEx is maintenance? And do you have a sense for any other major projects beyond 2020 that we should be considering in our, kind of, go-forward CapEx?

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Robert M. McNutt, Lamb Weston Holdings, Inc. – Senior VP & CFO [39]

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Yes. Carla, this is Rob. The maintenance level of CapEx, we've talked about in the past, has been in the $115 million to $125 million range, somewhere in that $120-ish million range. And really, the only thing that you may think too — think about is Tom's comment of, in the not-too-distant future, we're going to have to add some capacity. And so think about it in those terms. And we've talked about that in the past.

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Carla Casella, JP Morgan Chase & Co, Research Division – MD & Senior Analyst [40]

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Okay. Big. And then on the Thanksgiving timing shift, you mentioned it took about — it added about 1 point of growth this quarter. Did you — I don't think I heard you, did you quantify how much you expect it to take some growth in the next quarter?

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Dexter P. Congbalay, Lamb Weston Holdings, Inc. – VP of IR [41]

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Yes. It's Dexter, Carla. It's about the same. It's just — it's a pull-forward, that's all it is. So with that, it's going to be our last question. So this is Dexter. If anybody who wants to have a follow-up conversation, just e-mail me and we'll set up the time. And Happy New Year to everyone, and have a good weekend.

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Operator [42]

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Thank you very much. Ladies and gentlemen, this concludes today's conference. All participants may now disconnect.